Suppose there are three independent factors (F1, F2 and F3) in a multifactor Arbitrage Pricing Theory...

 

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Suppose there are three independent factors (F1, F2 and F3) in a multifactor Arbitrage Pricing Theory (APT) model of security returns. The following table contains information on the factor risk premiums, expected rates of change of the factors, and the corresponding factor betas estimated for a stock. The risk-free rate of interest is 4%. Factor Factor Risk Premium Expected Rate of Change Factor Betas F1 5% F2 2% 1% 0% 1.2 2% 0.9 1% -0.5 F3 Required: a. Calculate the expected rate of return on the stock, assuming the stock is fairly priced. (2 marks) b. Suppose that the actual rates of change turn out to be 1%, 2% and 4% on F1, F2 and F3 respectively. Calculate the revised expectations for the rate of return once the surprises become known. (3 marks) c. How should a researcher decide which factors to investigate for inclusion in an APT model of security returns? Provide two examples of suitable APT factors, excluding the market factor. (3 marks) Suppose there are three independent factors (F1, F2 and F3) in a multifactor Arbitrage Pricing Theory (APT) model of security returns. The following table contains information on the factor risk premiums, expected rates of change of the factors, and the corresponding factor betas estimated for a stock. The risk-free rate of interest is 4%. Factor Factor Risk Premium Expected Rate of Change Factor Betas F1 5% F2 2% 1% 0% 1.2 2% 0.9 1% -0.5 F3 Required: a. Calculate the expected rate of return on the stock, assuming the stock is fairly priced. (2 marks) b. Suppose that the actual rates of change turn out to be 1%, 2% and 4% on F1, F2 and F3 respectively. Calculate the revised expectations for the rate of return once the surprises become known. (3 marks) c. How should a researcher decide which factors to investigate for inclusion in an APT model of security returns? Provide two examples of suitable APT factors, excluding the market factor. (3 marks)

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a To calculate the expected rate of return on the stock assuming the stock is fairly priced we use t... View the full answer