Suppose that there are two independent factors, F1 and F2. The risk-free rate is 3%, and all stocks have independent firm-specific components with a standard deviation of 42%. Portfolios A and B are both well-diversified with the following properties: PortfolioBeta on F1Beta on F2Expected ReturnA1.82.132%B2.7-0.2127%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 (write answers as percentages, rounded to two decimal places). E(rp) = rf + (BP1 X RP1) + (BP2 X RP2) (Note: B = Beta)rf?%RP1?%RP2?%

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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 factors, F1 and F2. The risk-free rate is 3%, and all stocks have independent firm-specific components with a standard deviation of 42%. Portfolios A and B are both well-diversified with the following properties:

Portfolio	Beta on F1	Beta on F2	Expected Return
A	1.8	2.1	32%
B	2.7	-0.21	27%

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 (write answers as percentages, rounded to two decimal places).

E(rp) = rf + (BP1 X RP1) + (BP2 X RP2) (Note: B = Beta)

rf	?%
RP1	?%
RP2	?%

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