Question

Suppose that the market can be described by the following three sources of systematic risk with associated risk premiums. Factor Risk Premium Industrial production (I) 6 % Interest rates (R) 3 % Consumer confidence (C) 4 % The return on a particular stock is generated according to the following equation: r = 16% + 1.5I + 0.8R + 1.10C + e a-1. Find the equilibrium rate of return on this stock using the APT. The T-bill rate is 8%.

Answer 1

23.8%

Step-by-step explanation:

the return on the stock based on the beta factors given are:

E(r) = 8% + (1.5*6%) + (0.8*3) + (1.1*4) = 23.8%

Since the actual expected return is less than the equilibrium return, we can say that the stock is overpriced.