Question

Question 3

The following three factors have been identified as explaining a stock’s returns and its sensitivity to each factor and the risk premium associated with each factor is also calculated.
Gross Domestic Product (GDP) growth:  = 0.5; RP = 3%
Inflation rate:  = 0.7; RP = 3%

S&P’s 500 index return:  = 1.4; RP = 8% The risk-free rate is 4%

Using the asset pricing theory (APT) formula, calculate the expected return. (4 points)

Answer 1

Using the asset pricing theory formulae calculating the expected return:-

We know:-

Expected return= risk free rate+(beta× market return premium)

Return premium has already given and risk free rate and beta are also given,

So we have to just put the values to calculate the expected return.

Expected return= 4%+( 0.5× 3%) + ( 0.7× 3%) + ( 1.4× 8%)

Expected return= 4% + 0.015+ 0.021+0.112

Expected return= 4%+ 0.148

Expected return= 0.188

So expected return= 18.8%