Answer: There is no arbitrage opportunity because the factor sensitivities are identical

## Explanation In a two-factor arbitrage pricing theory (APT) model, an arbitrage opportunity exists when two assets have identical factor sensitivities (betas) but different expected returns. **Key Analysis:** - **Factor Sensitivities:** Both stocks have identical betas: - GDP beta: 1.1 for both DESolars and GERTech - CPI beta: 0.9 for both DESolars and GERTech - **Factor Surprises:** - GDP surprise = Actual GDP (2%) - Expected GDP (2%) = 0% - CPI surprise = Actual CPI (1.7%) - Expected CPI (1.5%) = 0.2% **Expected Return Calculation:** Using the APT model: Expected Return = Risk-free rate + β₁ × Factor₁ + β₂ × Factor₂ Since both stocks have identical factor sensitivities and are exposed to the same factor surprises, their expected returns should be identical according to the APT model. The slight difference in stated expected returns (4.9% vs 5.1%) is likely due to measurement error or other firm-specific factors, but does not represent a true arbitrage opportunity because the factor structure is identical. **Conclusion:** There is no arbitrage opportunity because the factor sensitivities are identical, meaning both stocks should have the same expected return in equilibrium according to the APT framework.

Author: Tanishq Prabhu