Tut7_2009 - R A = 3 0.7R M e A R B =-2 1.2R M e B With σ M...

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BUS3026W Finance II 2009 - Tutorial 7 Due: Monday 27 April ______________________________________________________________ Question One Consider the following multifactor (APT) model of security returns for a particular stock. Factor Factor Beta Factor Risk Premium Inflation 1.2 6% Industrial Production 0.5 8% Oil Prices 0.3 3% a. If T-bills currently offer a 6% yield, find the expected rate of return on this stock if the market views the stock as fairly priced. [3] b. Suppose that the market expected the values for the three macro factors given in column 1 below, but that the actual values turn out as given in column 2. Calculated the revised expectations for the rate of return on the stock once the “surprises” become known. [3] Factor Expected Rate of Change Actual Rate of Change Inflation 5% 4% Industrial Production 3% 6% Oil Prices 2% 0% Question Two Use the following data for problems a through d. Suppose that the index model for stocks A and B is estimated using excess returns with the following results:
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Unformatted text preview: R A = 3% + 0.7R M + e A R B = -2% + 1.2R M + e B With σ M = 20% R-SQ R A = 0.2 and R-SQ R B = 0.12 a. What is the standard deviation of each stock? [4] b. Break down the variance of each stock to the systematic and firm specific components [6] c. What is the covariance between each stock and the market index? [4] d. Are the intercepts of the two regressions consistent with the CAPM? Interpret their values. [4] Question Three Suppose that the market can be described by the following three sources of systematic risk with associated risk premiums. Factor Risk Premium Industrial production (I) 6% Interest rates (R) 2% Consumer confidence (C) 4% The return on a particular stock is generated according to the following equation: e C 75 . R 5 . I 1 % 15 r + + + + = Find the equilibrium rate of return on this stock using the APT. The T-bill rate is 6%. Is the stock over- or underpriced? Explain. [6]...
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