Stock Model
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Suppose stock returns can be explained by a two-factor model information for two diversified portfolios:
B1 B2 Expected Return
Portfolio A .85 1.15 16%
Portfolio B 1.45 -.25 12%
If the risk free rate is 4%, what are the risk premiums for each factor in the model?
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Solution Summary
This solution finds the risk premiums for factors in a stock two-factor model.
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The return of portfolio A is: rf + 0.85 * B1 + 1.15 * B2 = 16% = 0.16
The return of portfolio B is: rf + 1.45 * B1 - 0.25 * B2 = 12% = 0.12
Substituting in rf = 4% = ...
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