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    Security expected returns and betas in 3 well-diversified portfolios

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    Security expected returns and betas

    Security E(R) Beta
    1 10% 1.00
    2 12% 1.20
    3 13% 1.10

    Suppose there are three well-diversified portfolios, as shown above. An arbitrage opportunity is implied in these numbers. Show mathematically how to take advantage of it.

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    ANSWERS

    From the beta and the expected return, Security or Portfolio 3 is undervalued as its expected return is 13% instead of 11% (10% x 1.10). Hence, the strategy is I will buy Security 3 (hold it long) and using the ...

    Solution Summary

    The security expected returns and betas 3 well-diversified portfolio is determined.

    $2.19

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