Question

Consider the following simplified APT model: Factor Market Interest rate Yield spread Expected Risk Premium (%) 6.8 -0.6 4.7 Stock Market (61) 1.0 0.9 0.3 Factor Risk Exposures Interest Rate Yield Spread (62) (63) -1.2 -0.4 0.2 1.4 1.3 Calculate the expected return for each of the stocks shown in the table above. Assume rf=3.4%. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) Expected return P Expected return P2 Expected return P3

Answer 1

Expected return = risk free rate + $\sum_{}^{}$(risk premium * factor risk exposure)

Expected return P = 3.4% + (1.0 * 6.8%) + (-1.2 * -0.6%) + (-0.4 * 4.7%) = 9.04%.

Expected return P2 = 3.4% + (0.9 * 6.8%) + (0 * -0.6%) + (0.2 * 4.7%) = 10.46%.

Expected return P3 = 3.4% + (0.3 * 6.8%) + (1.3 * -0.6%) + (1.4 * 4.7%) = 11.24%.