Consider the following multifactor (APT) model of security returns for a particu

Question

Consider the following multifactor (APT) model of security returns for a particular stock.

If T-bills currently offer a 5% yield, find the expected rate of return on this stock if the market views the stock as fairly priced. (Do not round intermediate calculations. Round your answer to 1 decimal place. Omit the "%" sign in your response.)

Suppose that the market expected the values for the three macro factors given in column 1 below, but that the actual values turn out as given in column 2. Calculate the revised expectations for the rate of return on the stock once the "surprises" become known. (Do not round intermediate calculations. Round your answer to 1 decimal place. Omit the "%" sign in your response.)

  Factor Factor Beta Factor Risk Premium   Inflation 1.6               6%                Industrial production 1.1               7                   Oil prices 0.7               2                

Explanation / Answer

a)

Expected rate of return = Rf + sum of ( factor beta x factor risk premium)

                                = 5% + (1.6 x 6% +1.1 x7% +0.70 x2%)

                                = 5% + 18.70%

                                = 23.70%

b)

Expected rate of return = Rf + sum of ( factor beta x factor risk premium)

                                = 5% + (1.6 x 7% +1.1 x8% +0.70 x0)

                                = 5% + 20%

                                = 25%

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