Explanation:
According to the Arbitrage Pricing Theory (APT), assets should provide the same expected excess return per unit of risk (beta). Risk premium per unit of beta for XENA: Risk premium per unit of beta for YNN: Since XENA offers a higher risk premium per unit of risk compared to YNN, XENA is relatively undervalued, and YNN is relatively overvalued. To exploit this arbitrage opportunity, an investor should take a short position in the overvalued asset (YNN) and use the proceeds to take a long position in the undervalued asset (XENA).
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Q.57 Consider a single factor APT in a country where the risk-free rate is 8%. The stocks of XENA have a beta of 1.7 and an expected return of 19%. The stocks of YNN have a beta of 2.2 and an expected return of 15%. Assuming you wanted to exploit an arbitrage opportunity, you would take a short position in:
A
YNN and use the proceeds to take a long position in XENA
B
XENA and use the proceeds to take a long position in YNN
C
YNN and use the proceeds to take a long position in the riskless asset
D
XENA and use the proceeds to take a long position in the riskless asset
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