Question

Help Seve Check my Suppose there are two independent economic factors, M, and M. The risk free rate is 5% and all stocks have independent firm specific components with a standard deviation of 52%. Portfolios A and B are both well diversified. Portfolio Beta on M, Beta on M2 Expected Return (X) 1.6 12 What is the expected return-beta relationship in this economy? (Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected return-beta relationship E(IP) = 5.00% + BP1+ L BP2 < Prey 9 of 9 !!! Next o 9 e earch

Answer 1

Expected Return of A =Risk Free Rate +Beta M1* M1 Factor +Beta M2* M2 Factor
31% =5%+1.6*M1+2.5*M2
1.6*M1+2.5*M2=26%

For Portfolio B
12%=5%+2.4*M1-0.7*M2
7% =2.4*M1-0.7*M2

Multiplying with equation 1 and Multiplying 2 with equation 2 and subtracting we get:
4.8M1+7.5M2-78%-4.8M1+1.4M2+14%=0
8.9M2 =64%
M2 =64%/8.9%=7.19

M1 =5.01

Expected Relationship =5%+5.01*Bp1+7.19*Bp2