Problem 10-4

Suppose that there are two independent economic factors, F₁ and F₂. The risk-free rate is 5%, and all stocks have independent firm-specific components with a standard deviation of 35%. Portfolios A and B are both well-diversified with the following properties:

Portfolio			Beta on F1			Beta on F2			Expected Return
	A			1.1			1.5			25	%
	B			2.0			0.15			22	%

What is the expected return-beta relationship in this economy? Calculate the risk-free rate, r_f, and the factor risk premiums, RP₁ and RP₂, to complete the equation below. (Do not round intermediate calculations. Round your answers to two decimal places.)

E(r_P) = r_f + (_P1 RP₁) + (_P2 RP₂)

What is the rf %

RP1 %

RP2%