Solution:
We know that
First, we calculate the risk premium, for each of the two factors
and
We get the following equation to be solved
37 = 6 + 1.7 x + 2.4 x ---------------------------------- {A}
10 = 6 + 2.3 x + (-0.8) x ------------------------------ {B}
We multiply equation A by 2.3 and B by 1.7, we get
85.1 = 20.7 + 3.91 + 5.52
17 = 10.2 + 3.91 -1.36
- - - +
--------------------------------------------------
68.1 = 10.5 + 4.16
= 9.375%
Substituting the value of in equation A, we get
37 = 6 + 1.7 x + 2.4 x (9.375)
= 5%
Hence, the expected return-beta relationship is
E (rP) = 6% + 5 + 9.375
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