Answer-first summary for fast verification
Answer: 14%
## Explanation In a macroeconomic factor model, the expected return is given by the constant term (intercept) in the equation, since the factors $F_1$ and $F_2$ represent surprises with expected value of zero. For Stock X: Expected return = 8% (0.08) For Stock Y: Expected return = 16% (0.16) Portfolio weights: - Stock X: 25% (one quarter) - Stock Y: 75% (the rest) Portfolio expected return: $$E(R_p) = 0.25 \times 8\% + 0.75 \times 16\%$$ $$E(R_p) = 2\% + 12\% = 14\%$$ Therefore, the portfolio's expected return is **14%**.
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The returns of stocks X and Y are given by a macroeconomic factor model and expressed as follows:
where and reflect surprises in two macroeconomic factors. If a portfolio has one quarter of its investment in Stock X and the rest in Stock Y, the portfolio's expected return is closest to:
A
12%
B
14%
C
18%