Question

Consider a three-factor APT model. The factors and associated risk premiums are:

Factor	Risk Premium (%)
Change in GNP	+5.6
Change in energy prices	–1.6
Change in long-term interest rates	+2.6

Calculate expected rates of return on the following stocks. The risk-free interest rate is 5.6%.

a. A stock whose return is uncorrelated with all three factors. (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

Expected rate of return             %

b. A stock with average exposure to each factor (i.e., with b = 1 for each). (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

Expected rate of return             %

c. A pure-play energy stock with high exposure to the energy factor (b = 1.9) but zero exposure to the other two factors. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Expected rate of return             %

d. 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.) (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Expected rate of return             %

Answer 1

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