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Suppose a factor model is appropriate to describe the returns on a stock
Suppose a factor model is appropriate to describe the returns on a stock. The current expected return on the stock is 10.8 percent. Information about those factors is presented in the following chart:
a. What is the systematic risk of the stock return?
b. The firm announced that its market share had unexpectedly increased from 26 percent to 30 percent. Investors know from past experience that the stock return will increase by .80 percent for every 1 percent increase in its market share. What is the unsystematic risk of the stock?
c. What is the total return on this stock?
Expert Solution
a. The return of this stock is systematically affected by two market-wide factors: growth of GNP and inflation. The measures of the systematic risk affecting the stock are the two betas of 1.83 and - 1.39. They are the systematic risk of the stock.
b. Any factors, other than growth of GNP and inflation, that influence the return of the stock are unsystematic. Their effect will disappear if you hold the stock in a portfolio, One such factor in this example is the market share. The unsystematic risk attributable to this factor is 0.8. It is the sensitivity of the stock return to changes in market share.
c. The return on the stock is 14.22%. Here is why:
Return on the stock = Expected return + Unexpected Return = 10.8% + Unexpected return =
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