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Question
There are two independent economic factors, M1 and M2. The risk-free rate is 5%, and all stocks have independent firm-specific components with a standard deviation of 25%. Portfolios A and B are well diversified. Given the data below, which equation provides the correct pricing model?
| Portfolio | Beta on M1 | Beta on M2 | E[rp] | |
| A | 1.5 | 1.75 | 35% | |
| B | 1.0 | 0.65 | 20% |
A) E(rP) = 5 + 1.12βP1 + 11.86βP2
B) E(rP) = 5 + 4.96βP1 + 13.26βP2
C) E(rP) = 5 + 3.23βP1 + 8.46βP2
D) E(rP) = 5 + 8.71βP1 + 9.68βP2
Answer
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