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Suppose that there are two independent economic factors,F1andF2. The risk-free rate is 6%, and all stocks have independent firm-specific components with a standard deviation of

  1. Suppose that there are two independent economic factors,F1andF2. The risk-free rate is 6%, and all stocks have independent firm-specific components with a standard deviation of 45%. PortfoliosAandBare both well-diversified with the following properties:
Portfolio Beta onF1 Beta onF2 Expected Return
A 1.5 2.0 31%
B 2.2 0.2 27%

What is the expected return-beta SML equilibrium relationship in this economy?

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