Answer:
Short Position A, Long Position B
Step-by-step explanation:
Full question is "Consider the single factor APT. Portfolio A has a beta of 1.6 and an expected return of 20%. Portfolio B has a beta of .7 and an expected return of 16%. The risk-free rate of return is 9%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________."
CAPM Return = Rf+beta * Risk premium
A return = 0.09 + 1.6*Risk premium
0.2 = 0.09 + 1.6*Risk premium
1.6*Risk premium = 0.02 - 0.09
1.6*Risk premium = 0.11
Risk premium = 0.11/1.6
Risk premium = 0.06875
Risk premium = 6.88%
B return = 0.09 + 0.7*Risk premium
0.16 = 0.09 + 0.7*Risk premium
0.7*Risk premium = 0.16 - 0.09
0.7*Risk premium = 0.07
Risk premium = 0.07/0.7
Risk premium = 0.1
Risk premium = 10%
Hence, we should take a short position in A and a long position in an equally weighted portfolio of B.