Question

b. The estimatedfactor sensitivities of HSULtdto Fama-French factors and the risk premia associated with those factors are given in the following table:Factor Sensitivity	Risk Premium (%)
Market factor	0.2	4.3
Size factor	-0.2	2.4
Value factor	-0.3	4.1

i.Based on the Fama-French model, calculate the required return for HSU Limited using these estimates. Assume that the Treasury billrate is 5 percent. (4marks)

ii. What do you know about HSU Limitedbased on its factor sensitivities?(6marks)

Answer 1

i) fama french model

Required Return = risk free rate + factor sensitivity * market factor risk premium + factor sensitivity * size factor premium + factor sensitivity * value factor premium

= 5% + 0.2 * 4.3% + (-0.2) * 2.4% + (-0.3) * 4.1%

= 5% + 0.86% - 0.48% - 1.23%

= 4.15%

ii) The 3 factor fama french model consists of market risk premium, SMB (small minus big) and, HML (high minus low). This model considers that valu and small cap stock outperform the market on a regular basis. On the basis of the factor sensitivity, we can say that the company is having negative exposure to both Size factor and value factor. The company generates negative returns by being exposed to them . The only excess return which they get is from market risk premium.

From the factors sensitivity, we can also say that it is exposed to long cap and growth company, because the factor sensitivities to both the size and value factors are negative. if the factors would have been high and positive then the company would have been exposed to small cap and value company.