3. (8 points) Consider the following multi-factor (APT) model of security returns for shares of company ABC and DEF.

Factor Factor beta Factor expected return

ABC DEF

Inflation 1.2 0.4 6%

Industrial production 0.5 0.8 8%

Oil price 0.3 1.5 3%

(a) (3 points) If T-bills currently oer a 1% yield, what is the expected return on share ABC and DEF?

(b) (2 points) Assume that company ABC has a dividend payment $5 per year per share that is expected to be paid every year forever. How much is an investor willing to pay for a share of ABC?

(c) (3 points) Suppose that the market expected the values for the three macro factors are as given in column 1 below, but that the actual values turn out as given in column 2. Calculate the revised expectations for the rate of return on the stocks ABC and DEF, respectively, once the "surprises" become known.