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Suppose there are two independent economic factors, M _{1 }and M _{2 }. The risk-free rate is 7%, and all stocks have independent firm-specific components with a standard deviation of 50%. Portfolios A and B are both well diversified.
Portfolio |
Beta on M _{1} |
Beta on M _{2} |
Expected Return (%) |
A |
1.8 |
2.1 |
40 |
B |
2.0 |
20.5 |
10 |
What is the expected return–beta relationship in this economy? (LO 7-5)
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