Question

Suppose two factors are identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 6% and IR 5%. A stock with a beta of 1 on IP and 0.8 on IR currently is expected to provide a rate of return of 11%. If industrial production actually grows by 7%, while the inflation rate turns out to be 8%, what is your best guess for the rate of return on the stock

Answer 1

the best guess is 14.4%

Step-by-step explanation:

The computation of the best guess for the rate of return on the stock is shown below

Before

11% = α + [6% × 1] + [5% × 0.8]

11% = α + 6% + 4%

α = 1%

Now With the changes:

= 1% + [7% × 1] + [8% × 0.8]

= 1% + 7% + 6.4%

= 14.4%

Hence, the best guess is 14.4%