1. Consider a 3-factor Arbitrage Pricing Theory (APT) model. Assuming a risk-free rate of 4%, calculate the expected return of this stock.                                                                                           

Factor	Risk Premium	Sensitivity to each factor
Change in GDP	5%	1
Change in interest rate	1%	0.5
Inflation ratio	2.5%	0.2

(4 marks)

2. Consider the following portfolio composed of 3 stocks (A, B, C):

Stock	Quantity	Price (£)	Beta
A	500	1.5	0.8
B	520	1.7	0.97
C	610	1.1	1.04

What is the beta of this portfolio?                                                             (4 marks)

1. Explain the security market line in the context of the CAPM and examine how this can be used to identify whether a security is under-priced or over-priced.                                                                                                      (5 marks)

2. Critically examine the empirical evidence in relation to the CAPM.                                                                                                                           (8 marks)

Answer rating: 100% (QA)

ANSWER 1 To calculate the expected return of the stock using the 3factor APT model we need to multiply the risk premium by the sensitivity of each fac... View the full answer