Question

Please show all the works and answer all the numbers accordingly (like the way the question is aking ). Thanks

Check my work Suppose there are two independent economic factors, M, and M2. The risk-free rate is 4%, and all stocks have independent firm-specific components with a standard deviation of 53%. Portfolios A and B are both well diversified. Portfolio Expected Return (%) points Beta on MiBeta on M2 1.7 1.9 1.8 -0.7 B eBook Print What is the expected return-beta relationship in this economy? (Do not round intermediate calculations. Round your answers to 2 decimal places.) References Expected return-beta relationship E(P) = : :% + BP1+ L BP2

Answer 1

E(rp) = rf + (beta1 * RP1) + (beta2 * RP2)
32% = 4% + (1.7 * RP1) + (1.9 * RP2) => First equation
13% = 4% + (1.8 * RP1) + ((-0.7) * RP2) => second equation
Multiply first equation by 1.8 and second equation by 1.7
57.6% = 7.2% + (3.06 * RP1) + (3.42 *RP2)
22.1% = 6.8% + (3.06 * RP1) + (-1.19 * RP2)
Substract Equation 2 from equation 1
35.5% =0.4% + (4.61 * RP2)
RP2 = (35.5% - 0.4%) / 4.61 = 7.61%
RP1 = (32% - 4% - (1.9*7.61))/1.7 = 7.96

Expected return-beta relationship E(rp) = 4% + 7.96 BP1 + 7.61 BP2