Suppose that there are two independent economic factors, F1 and F2. The risk-free rate is 10%, and all stocks have independent firm-specific components with a standard deviation of 50%. Portfolios A and B are both well-diversified with the following properties: PortfolioBeta on F1Beta on F2Expected ReturnA1.22.028% B3.1-0.2023% What is the expected return-beta relationship in this economy? Calculate the risk-free rate, rf, and the factor risk premiums, RP1 and RP2, to complete the equation below. (Do not round intermediate calculations. Round your answers to two decimal places.)E(rP) = rf + (βP1 × RP1) + (βP2 × RP2)

Beta: It is defined as a computation of the risk or volatility of a portfolio or security.

Answered: Suppose that there are two independent…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 14P

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Suppose that there are two independent economic factors, F₁ and F₂. The risk-free rate is 10%, and all stocks have independent firm-specific components with a standard deviation of 50%. Portfolios A and B are both well-diversified with the following properties:

Portfolio	Beta on F₁	Beta on F₂	Expected Return
A	1.2	2.0	28%
B	3.1	-0.20	23%

What is the expected return-beta relationship in this economy? Calculate the risk-free rate, r_f, and the factor risk premiums, RP₁ and RP₂, to complete the equation below. (Do not round intermediate calculations. Round your answers to two decimal places.)

E(r_P) = r_f + (β_P₁ × RP₁) + (β_P₂ × RP₂)

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