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QUESTION 7 Consider a two-factor economy. Assets A and B are well-diversified portfolios. The risk-free rate is 1%. The standard deviations of the excess return

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QUESTION 7 Consider a two-factor economy. Assets A and B are well-diversified portfolios. The risk-free rate is 1%. The standard deviations of the excess return of factor portfolios 1 and 2 are 18% and 15% respectively. The two factor portfolios are uncorrelated. Asset Beta 1 Beta 2 Forecasted Return 0.5 1.0 7.00% B 1.0 -0.5 8.00% 1) Assume the market is arbitrage free. What are the risk premiums of factor portfolios 1 and 2? (15 marks)

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