Question

The following table shows the sensitivity of four stocks to the three Fama−French factors. Assume that the interest rate is 2%, the expected risk premium on the market is 7%, the expected risk premium on the size factor is 3.7%, and the expected risk premium on the book-to-market factor is 4.9%.

	Boeing	Johnson & Johnson	Dow Chemical	Google
Market	1.21	0.60	1.71	1.46
Size	−0.81	−0.18	0.31	−0.44
Book-to-market	0.47	−0.10	1.70	−1.25

Calculate the expected return on each stock. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Expected Return
Boeing	%
Johnson & Johnson	%
Dow Chemical	%
Google	%

Answer 1

Answer :

Expected Return = Risk free Rate + Beta of market * Expected Risk Premium on the market + Beta of Size * Expected Risk Premium on the size + Beta of Book-to-market * Expected Risk Premium on the book to market

Expected Return on Boeing = 2% + [1.21 * 7%] + [(-0.81) * 3.7%] + [0.47 * 4.9%]

= 2% + 8.47% - 2.997% + 2.303%

= 9.776% or 9.78%

Expected Return on Johnson & Johnson = 2% + [0.60 * 7%] + [(-0.18) * 3.7%] + [(-0.10) * 4.9%]

= 2% + 4.2% - 0.666% - 0.49%

= 5.044% or 5.04%

Expected Return on Dow Chemical = 2% + [1.71 * 7%] + [0.31 * 3.7%] + [1.70 * 4.9%]

= 2% + 11.97% + 1.147% + 8.33%

= 23.447% or 23.45%

Expected Return on Google = 2% + [1.46 * 7%] + [(-0.44) * 3.7%] + [(-1.25) * 4.9%]

= 2% + 10.22% - 1.628% - 6.125%

= 4.467% or 4.47%