Question

A researcher has determined that a two-factor model is appropriate to determine the return on a stock. The factors are the percentage change in GNP and an interest rate. GNP is expected to grow by 4.1 percent, and the interest rate is expected to be 3.6 percent. A stock has a beta of 1.8 on the percentage change in GNP and a beta of –.8 on the interest rate. If the expected rate of return on the stock is 14 percent, what is the revised expected return on the stock if GNP actually grows by 3.7 percent and the interest rate is 3.9 percent? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Expected rate of return on the stock = 14%

Revised expected return on the stock = Expected rate of return + beta₁ * (actual change in GNP - expected change in GNP) + beta₂ * ( actual change in interest rate - expected change in interest rate)

Revised expected return on the stock = 14% + 1.8 * ( 3.7% - 4.1 %) + (–.8) * (3.9% - 3.6%)

Revised expected return on the stock = 14% + 1.8 * (-0.4%) + (-.8) * (0.3%)

Revised expected return on the stock = 14% - 0.72% -0.24%

Revised expected return on the stock = 13.04%