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 45%.

Portfolios A and B are both well-diversified with the following properties:

Portfolio Beta on F1 Beta on F2 Expected Return A 1.5 2.0 31%

B 2.2 −0.2 27%

What is the expected return–beta relationship in this economy?

 P-69