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Consider an economy where the market can be described by three sources of systematic risk (F1,

F2, and F3) with associated risk premiums RP1 = 5%, RP2 = 2%, and RP3 = 4%. The return on stock ABC is generated according to the following equation:

rABC=0.13+1.0F1+0.5F2+0.75F3+eABC

Assume that the stock is currently priced at $50 per share and T-bill rate is 5%.

1.      What is the equilibrium rate of return for stock ABC using the APT? 

2.      Is stock ABC underpriced or overvalued? Explain

3.      If the expected price next year will be $56, what is the stock price now that will not allow for arbitrage profits?

4.      Assume that the T-bill rate decreases to 3%, with the other variables remaining unchanged. Would you recommend to buy or sell stock ABC?

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