Consider a three-factor APT model. The factors and associated risk premiums are
ID: 2740979 • Letter: C
Question
Consider a three-factor APT model. The factors and associated risk premiums are
A stock whose return is uncorrelated with all three factors. (Round your answer to 1 decimal place.)
A stock with average exposure to each factor (i.e., with b = 1 for each). (Round your answer to 1 decimal place.)
A pure-play energy stock with high exposure to the energy factor (b = 2) but zero exposure to the other two factors. (Round your answer to 1 decimal place.)
An aluminum company stock with average sensitivity to changes in interest rates and GNP, but negative exposure of b = –1.5 to the energy factor. (The aluminum company is energy-intensive and suffers when energy prices rise.) (Round your answer to 2 decimal places.)
Factor Risk Premium Change in GNP 5.5 % Change in energy prices –1.5 Change in long-term interest rates +2.5Explanation / Answer
a.
Expected rate of return 5 %
b.
5 + 1(5.5) + 1(-1.5) + 1(2.5) = 11.5%
Expected rate of return 11.5%
c.
5 + 0(5.5) + 2.5(-1.5) + 0(2.5) = 1.25%
Expected rate of return 1.25%
d.
5 + 1(5.5) + (-1.5)(-1.5) + 1(2.5) = 15.25%.
Expected rate of return 15.25%