Suppose a three-factor APM holds and the risk-free rate is 6 percent. You are interested in two particular stocks. A and B. The returns on both stocks are related to factors 1 and 2 as follows.
r = 0.06 + b1 (0.09) - b2 (0.03) + b3 (0.04)
The sensitivity coefficients for the two stocks are given below.
|
Stock
|
b1
|
b2
|
b2
|
|
A
|
0.70
|
0.80
|
0.20
|
|
B
|
0.50
|
0.04
|
0.20
|
Calculate the expected returns on both stocks. Which stock requires a higher return?