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. Portfolios A and B are both well diversified.
Portfolio Beta on M1 Beta on M2 Expected Return (%)
A 1.6 2.2 37
B 2.1 -0.6 15
What is the expected return–beta relationship in this economy?
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