Question

Suppose that there are two independent economic factors, F1 and F2. The risk-free rate is 6%, and all stocks have independent firm-specific components with a standard deviation of 53%. Portfolios A and B are both well-diversified with the following properties: Portfolio Beta on F1 Beta on F2 Expected Return A 1.5 1.9 31 % B 2.5 –0.19 28 % 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)

rf:_______%

RP1:_____%

RP2:_____%

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

- Q v urax 3 ENG | W 10:13 16-03-2020 ... o X : BM41 2 x BM fix BN BL BO BP BQ BR BS BT BU BV BW 41 42 THIS IS A TWO FACTOR ECONOMY Portfolio A = 31% = 6% + 1.5(P1) + 1.9(P2) 25% = 1.5(P1) + 1.9(P2) eq(1) EXPECTED RETURN-BETA RELATIONSHIP = E(rp) = Rf + beta1(P1) + beta2(P2) Portfolio B = 28% = 6% + 2.5(P1) +(-0.19)(P2) 22% = 2.5(P1) +(-0.19)(P2) eq(2) 45 MULTIPLY eq(2) BY 10 18 ELIMINATION METHOD EQUATION 1 AS IT IS ------> [22% = 2.5(P1) +(-0.19)(P2)] X 10 ADD 50 25% = 1.5(P1) + 1.9(P2) 220% = 25(P1) +(-1.9)(P2) 245% = 26.5 (P1) P1 = 9.245283 % NOW eq(1): 51 52 53 25% = 1.5(P1) + 1.9(P2) 25% = 1.5(9.245283%) + 1.9(P2) 25% = 13.8679245% + 1.9(P2) P2 = 5.858987% 54 55 56 57 EXPECTED RETURN-BETA RELATIONSHIP = E(rP) = Rf + beta1(P1) + beta2(P2) = 6% + beta1(9.25%) + beta2(5.86%). Rf 58 6% RP1 RP2 9.25% [ROUNDED TO 2 DECIMALS] 5.86% [ROUNDED TO 2 DECIMALS] 63 ... UTILITY, SHARPE, beta coNvexity DGM beta port future INDEX INTL CAP BUD SANDRINE LEASING PORTFOLO Q DIR right clean YIELD bond portfolio ... Đ

- Q v urax 3 ENG | W 10:13 16-03-2020 ... o X : BM41 2 x BM fix BN BL BO BP BQ BR BS BT BU BV BW 41 42 THIS IS A TWO FACTOR ECONOMY Portfolio A = 31% = 6% + 1.5(P1) + 1.9(P2) 25% = 1.5(P1) + 1.9(P2) eq(1) EXPECTED RETURN-BETA RELATIONSHIP = E(rp) = Rf + beta1(P1) + beta2(P2) Portfolio B = 28% = 6% + 2.5(P1) +(-0.19)(P2) 22% = 2.5(P1) +(-0.19)(P2) eq(2) 45 MULTIPLY eq(2) BY 10 18 ELIMINATION METHOD EQUATION 1 AS IT IS ------> [22% = 2.5(P1) +(-0.19)(P2)] X 10 ADD 50 25% = 1.5(P1) + 1.9(P2) 220% = 25(P1) +(-1.9)(P2) 245% = 26.5 (P1) P1 = 9.245283 % NOW eq(1): 51 52 53 25% = 1.5(P1) + 1.9(P2) 25% = 1.5(9.245283%) + 1.9(P2) 25% = 13.8679245% + 1.9(P2) P2 = 5.858987% 54 55 56 57 EXPECTED RETURN-BETA RELATIONSHIP = E(rP) = Rf + beta1(P1) + beta2(P2) = 6% + beta1(9.25%) + beta2(5.86%). Rf 58 6% RP1 RP2 9.25% [ROUNDED TO 2 DECIMALS] 5.86% [ROUNDED TO 2 DECIMALS] 63 ... UTILITY, SHARPE, beta coNvexity DGM beta port future INDEX INTL CAP BUD SANDRINE LEASING PORTFOLO Q DIR right clean YIELD bond portfolio ... Đ