Question: We believe that the single factor model can predict any individual assets realized rate of return well. Both Portfolio A and Portfolio B are well-diversified:

We believe that the single factor model can predict any individual assets realized rate of return well. Both Portfolio A and Portfolio B are well-diversified: ri = E(ri) + iF + Ei, where E(ei) = 0 and Cov(F, i) = 0

	A	B
	1.2	0.8
E(r)	0.1	0.08

(1) What is the rate of return of the risk-free asset?

(2) What is the expected rate of return of the well-diversified portfolio C with C = 1.6, which also exists in the market?

(3) A fund constructs a well-diversified portfolio D. Studies show that D = 0.6. The expected rate of return of D is 0.06. Is there an arbitrage opportunity? If so, construct a trading strategy to earn profits with no risk. If not, why?

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