Question: Assume that security returns are generated by the following model, Ri=0;+Bw.iRw+ Ej where R; is the excess return for security i, Rw is the market

Assume that security returns are generated by the following model, Ri=0;+Bw.iRw+

Assume that security returns are generated by the following model, Ri=0;+Bw.iRw+ Ej where R; is the excess return for security i, Rw is the market excess returns in the world stock market, and Ej is firm-specific events. The risk-free rate is 2%. Suppose that there are two well diversified portfolios: X and Z, characterized by the following data: Expected excess return, E(R;) 0.8 Portfolio X Portfolio Z 8.0% 18.0% 1.6 a. (5points) Suppose portfolio X is fairly priced, what is the expected return-beta relationship in this market? b. (10 points) Suppose the assumptions in parts (a) continue to hold. Calculate the alpha of portfolio Z. Is there an arbitrage opportunity in this market? If so, describe a strategy and compute its profit. In the case there are multiple strategies, you only need to show one

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