Suppose that there are two independent economic factors F1 and F2. The risk-free rate is 5%,...
Suppose that there are two independent economic factors F1 and F2. The risk-free rate is 5%, and all stocks have independent firm-specific components with a standard deviation of 45%. The following are well-diversified portfolios:
|
Portfolio |
Beta on F1 |
Beta on F2 |
Expected Return |
| A | 1 | 2 | 19% |
| B | 2 | 1 | 24% |
What is the expected return-beta relationship in this economy?
Homework Answers
| Expected return = risk free rate+M1 beta*M1 risk premium+M2 beta*M2 risk premium | |||||||||
| 19=5+1*M1 risk premium + 2*M2 risk premium | |||||||||
| 14=1*M1 risk premium + 2*M2 risk premium……(1) | |||||||||
| 24=5+2*M1 risk premium + 1*M2 risk premium | |||||||||
| 19=2*M1 risk premium + 1*M2 risk premium……(2) | |||||||||
| Solving (1) & (2) simultaneously we get | |||||||||
| M1 risk premium=8 | |||||||||
| M2 risk premium=3 | |||||||||
| Expected return Beta relationship is: | |||||||||
| E{r}=5% + Beta M1*8 + Beta M2*3 |
Add Answer to:
Suppose that there are two independent economic factors F1 and
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