Question: PLEASE SHOW YOUR WORK. Consider a one-factor economy in which all portfolios are well-diversified. Portfolio A has a beta of 2.0 and an expected return

PLEASE SHOW YOUR WORK.

Consider a one-factor economy in which all portfolios are well-diversified. Portfolio A has a beta of 2.0 and an expected return of 22%. Portfolio B has a beta of 1.5 and an expected return of 17%. The risk-free rate of return is 4%.

a) Use the ratio of risk premium to beta to identify the arbitrage opportunity.

b) Based on your answer to part a), what would be the arbitrage strategy? State what to buy and what to sell. Please substantiate your answers with all appropriate calculations.

c) Based on your answers to parts a) and b), calculate the magnitude of the arbitrage profit per dollar of investment. Please substantiate your answers with all appropriate calculations.

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