Assume that the single index model holds for all securities and an investor comes up...
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Finance
Assume that the single index model holds for all securities and an investor comes up with the following equation for the return of the well diversied portfolio P:
rP = 16% + 0.5Rm
where Rm is an excess return on the market. The risk-free rate is 2% and the market expected return is 10%.
Does APT hold for portfolio P?
Does an arbitrage opportunity exist in this economy? If so, what would be an arbitrage strategy?
Now suppose that portfolio P is not welldiversied so that: rP= 16% + 0.5Rm + eP where ePis unexpected contribution from portfolio specic risk to the return of P. Does an arbitrage opportunity exist? Why? If yes, what is an arbitrage strategy?
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