consider a well-diversified portfolio, a, in a two-factor economy. the risk-free rate is 6%, the risk premium on the first factor portfolio is 4% and the risk premium on the second factor portfolio is 3%. if portfolio a has a beta of 1.2 on the first factor and. 8 on the second factor, what is its expected return

Question

Business

Hezekiah

4 November, 16:18

consider a well-diversified portfolio, a, in a two-factor economy. the risk-free rate is 6%, the risk premium on the first factor portfolio is 4% and the risk premium on the second factor portfolio is 3%. if portfolio a has a beta of 1.2 on the first factor and. 8 on the second factor, what is its expected return

+1

Answers (1)

Know the Answer?

Brenden Mccann · Answer 1

The expected return for a well diversified portfolio is 13.20%

Explanation:

The formula for multi-factor Capital Asset Pricing Model is given below

Expected return=Rf+Beta1 * (RP1) + Beta2 * (RP2)

Rf is the risk free rate of return is 6%

Beta1 is 1.2

RP1 is the risk premium on the first factor is 4%

Beta2 is 0.8

RP2 is the risk premium on the first factor is 3%

Expected return=6% + (1.2*4%) + (0.8*3%)

Expected return is 13.20%

This expected return on well diversified portfolio would have a return close 13.20%

A non-diversified factor 1 only investment would have 10.8% (6% + (1.2*4%)) which lower compared to a diversified portfolio

A non-diversified factor 2 only investment would have 8.40% (6% + (0.8*3%)) which lower compared to a diversified portfolio