In: Finance
Suppose that there are two independent economic factors, F1 and F2. The risk-free rate is 9%, and all stocks have independent firm-specific components with a standard deviation of 49%. Portfolios A and B are both well-diversified with the following properties:
Portfolio | Beta on F1 | Beta on F2 | Expected Return | ||||||||
A | 2.4 | 2.6 | 27 | % | |||||||
B | 3.0 | –0.26 | 22 | % | |||||||
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.