Question: You would like to use the Arbitrage Pricing Theorem (APT) to price securities in financial markets. To do so, you have decided that there are

You would like to use the Arbitrage Pricing Theorem (APT) to price securities in financial markets. To do so, you have decided that there are 3 relevant risk factors to consider, GNP growth, interest rates, and market returns. You are examining two stocks, Mars and Venus. Stock Mars has the following beta values for the three factors respectively (GNP growth: 1.1 interest rates 2.0, market returns: 0.5). Stock Venus has the following beta values for the three factors respectively (GNP growth: 0.7, interest rates: 1.0, market returns: 1.5). In addition, the risk-free rate is estimated to be 1%, and the 3 factors have the following factor risk premiums (GNP growth: 2%, interest rates: 1%, and market returns: 5%). a) Determine the expected returns for stocks Mars and Venus. (4 marks) b) You had initially expected that the three factors would have values of (GNP growth = 3%, interest rates = 1%, and market returns = 10%). Instead, it turned out that the 3 factors actually have values (GNP growth = 4%, interest rates = 3% and market returns = 7%). Determine the impact on stock Venus due to the "surprise" component of these factors. (2 marks)

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