An investor holds a portfolio of stocks that she thinks is influenced by only two basic economic factors—inflation and the economy’s output. Diversification once again plays a role, because the portfolio’s sensitivity to all other factors can be eliminated by diversification. Portfolio return varies directly with output and inversely with inflation. Each of these factors has an expected value, and the portfolio has an expected return when the factors are at their expected values. If either or both of the factors deviate from expected value, the portfolio return will be affected. We must measure the sensitivity of each stock in our investor’s portfolio to changes in each of the two factors. Each stock will have its own sensitivity to each of the factors. For example, stock #1 (a mortgage company) may be particularly sensitive to inflation and have a sensitivity of 2.0, while stock #2 (a food manufacturer) may have a sensitivity to inflation of only 1.0.