Question 1. Suppose the market can be described by the following three sources of systematic risk with associated risk premiums.
Factor Risk Premium
Industrial production (I) 7%
Interest rates ( R) 3
Consumer confidence ( C) 5
The return on a particular stock is generated according to the following equation:
R = 10% + 1.5 I + 0.6 R + .70 C + e
Find the equilibrium rate of return on this stock using the APT. The T-bill rate is 5%.
Is the stock over- or under-priced? Explain.
Question 2. The expected return on the stock market is 10% with a standard deviation of 27%. The risk free rate is 3%. AB Corp. has covariance (COV) of 0.075 with the market return. The stock currently trades at $100 and is expected to increase to $114. What would be the required return for this stock? Would you recommend purchase of the stock now? Why or why not?
Question 3. Sam Tsantes has analyzed two stocks, Acme Airlines and Ajax Travel Associates. His analysis concludes that Acme has a 20% chance of producing a return of 10% and an 80% chance of producing a return of 15%. At the same time, Ajax has a 40% chance of losing 25% and a 60% chance of producing a return of 50%. If Sam invests $70,000 in Acme shares and $30,000 in Ajax shares. What is the expected return on the portfolio?
Question 4. An analyst values a newly issued, 10-year, 9 percent annual coupon bond at par as of April 1, 2000. On April 1, 2003, the market prices the bond to yield 8.3 percent. What is the price of the bond on April 1, 2003?