Question

Portfolio A has a beta of 1.0 and an expected return of 22%. Portfolio B has a beta of 2.0 and an expected return of 17%. The risk-free rate of return is 2%. Is there an opportunity for arbitrage: (Please explain your answer)

Answer 1

Yes, there is an opportunity.

Step-by-step explanation:

Beta is an indicator of the risk of any portfolio. The higher beta, the greater the risk. Therefore, the expected return of that portfolio should be higher.

Portfolio B has a higher Beta than portfolio A, but a lower expected return, so we say that the portfolio B is more expensive than it's value. So, there is an opportunity for arbitrage. You should sell the protfolio B and buy the portfolio A, and win the difference between both operations, with no risk.