A k-factor model is a model where each stock’s return is generated by systematic risks on which we want to focus. We may believe that these three are sufficient to describe the systematic risks that influence stock returns. For example we can construct a three-factor model by using inflation, GNP, and the change in interest rates as systematic sources of risk, or factors. In contrast, researchers frequently use a one-factor model (Market model) for returns. They do not use all of the sorts of economic factors we used previously as examples; instead they use an index of stock market returns—like the S&P 500, or even a more broadly based index with more stocks in it—as the single factor. e. Consider the following statement: For the APT to be useful, the number of systematic risk factors must be small. Do you agree or disagree with this statement? Why? Yes because i t takes a considerable amount of research to determine how sensitive a security is to various macroeconomic risks. Which factors, and how many of them are used, are subjective choices – which means investors will have varying results depending on their choice. However, four or five factors will usually explain most of a security's return.
2. You own stock in the Lewis-Striden Drug Company. Suppose you had expected the following events to occur last month. a. The government would announce that real GNP would have grown 1.2 percent during the previous quarter. The returns of Lewis-Striden are positively related to real GNP.b. The government would announce that inflation over the previous quarter was 3.7 percent. The returns of Lewis-Striden are negatively related to inflation.c. Interest rates would rise 2.5 percentage points. The returns of Lewis-Striden are negatively related to interest rates.d. The president of the firm would announce his retirement. The retirement would be effective six months from the announcement day. The president is well liked: in general he is considered an asset to the firm.e. Research data would conclusively prove the efficacy of an experimental drug. Completion of the efficacy testing means the drug will be on the market soon. Suppose the following events actually occurred. a. The government announced that real GNP grew 2. 3 percent during the previous quarter. b. The government announced that inflation over the previous quarter was 3.7 percent. c. Interest rates rose 2.1 percentage points. d. The president of the firm died suddenly of a heart attack.
You've reached the end of your free preview.
Want to read all 7 pages?