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?
a. E(rP) = 5 + 1.12bP1 + 11.86bP2
b. E(rP) = 5 + 4.96bP1 + 13.26bP2
c. E(rP) = 5 + 3.23bP1 + 8.46bP2
D. E(rP) = 5 + 8.71bP1 + 9.68bP2
Answer: D. E(rP) = 5 + 8.71bP1 + 9.68bP2