Question
In: Finance
David McClemore, the CFO of Ultra Bread, has decided to use an APT model to estimate...
David McClemore, the CFO of Ultra Bread, has decided to use an APT model to estimate the required return on the company's stock. The risk factors he plans to use are the risk premium on the stock market, the inflation rate, and the price of wheat. Because wheat is one of the biggest costs Ultra Bread faces, he feels this is a significant risk factor for Ultra Bread. How would you evaluate his choice of risk factors? Are there other risk factors you might suggest?
Solutions
Expert Solution
1. Arbitrage Pricing Theory suggests that there are multiple factors which contributes to the calculation of expected return of a portfolio unlike Capital Asset Pricing Model where only market risk is taken into account.
2. Arbitrage Pricing Theory (APT) introduces the concept that risk of a porfolio not only consists of market risk but also the business risk. Both Systematic and Unsystematic risk lies in a portolio. Hence based on APT usage of Stock market, inflation rate and proce of wheat is justified.
3. In addition to the above risk factors the following can also be used, exchange rate if it has international exposure, interest rates, Gross Domestic Product...
Formula to calculate expected return under APT,
ke = risk free return + beta of factor 1* risk premium of factor 1 + beta of factor 2 * risk premium of factor 2 + ...+ beta of factor n * risk premium of factor n
jeff jeffy answered 2 years agoRelated Solutions
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