Arbitrage

Water Cooler Investing
#1

Hi all,

I’m new here so apologize in advance if this is the incorrect sub-forum for this topic.

I’m currently completing a question which gives that:

Asset z has an expected return of 0% and it has a beta of -0.5. Risk free return = 5% and market Return = 10%

From CAPM I get that the return on asset z is 0.05 -0.5(0.1-0.05) = 0.025: 2.5%

Thus the asset is overvalued.

However, I’m struggling to grasp how this overvaluation can be taken advantage of, with the options of selling and purchasing the risk free asset, market portfolio and asset z.

#2

Unless there is a futures/forward market for z I don’t see how you can do it risk-free (arbitrage).

If you can short z, you can invest the proceeds in the risk-free asset and make a profit if the price of z falls as expected, but that’s not arbitrage: there’s risk that the price will rise.