Page 326 1. Suppose that two factors have been identified for the U.S. economy: the growth...

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Page 326 1. Suppose that two factors have been identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 3%, and IR 5%. A stock with a beta of 1 on IP and .5 on IR currently is expected to provide a rate of return of 12%. If industrial production actually grows by 5%, while the inflation rate turns out to be 8%, what is your revised estimate of the expected rate of return on the stock? 2. The APT itself does not provide guidance concerning the factors that one might expect to determine risk premiums. How should researchers decide which factors to investigate? Why, for example, is industrial production a reasonable factor to test for a risk premium? 3. If the APT is to be a useful theory, the number of systematic factors in the economy must be small. Why? 10. Consider the following multifactor (APT) model of security returns for a particular stock. Factor Beta Factor Risk Premium Factor Inflation 1.2 Industrial production 0.5 Oil prices 0.3 6% 8 3 a. If T-bills currently offer a 6% yield, find the expected rate of return on this stock if the market views the stock as fairly priced. b. Suppose that the market expects the values for the three macro factors 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 stock once the "surprises" become known. Factor Inflation Expected Value Actual Value 5% 4% Industrial production 3 6 Oil prices 2 0 Page 326 1. Suppose that two factors have been identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 3%, and IR 5%. A stock with a beta of 1 on IP and .5 on IR currently is expected to provide a rate of return of 12%. If industrial production actually grows by 5%, while the inflation rate turns out to be 8%, what is your revised estimate of the expected rate of return on the stock? 2. The APT itself does not provide guidance concerning the factors that one might expect to determine risk premiums. How should researchers decide which factors to investigate? Why, for example, is industrial production a reasonable factor to test for a risk premium? 3. If the APT is to be a useful theory, the number of systematic factors in the economy must be small. Why? 10. Consider the following multifactor (APT) model of security returns for a particular stock. Factor Beta Factor Risk Premium Factor Inflation 1.2 Industrial production 0.5 Oil prices 0.3 6% 8 3 a. If T-bills currently offer a 6% yield, find the expected rate of return on this stock if the market views the stock as fairly priced. b. Suppose that the market expects the values for the three macro factors 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 stock once the "surprises" become known. Factor Inflation Expected Value Actual Value 5% 4% Industrial production 3 6 Oil prices 2 0