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Suppose that two factors have been identified for the U
Suppose that two factors have been identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 3%, and IR 5%. A stock with a beta of 1 on IP and .5 on IR currently is expected to provide a rate of return 12%. If industrial production actually grows by 5%, while the inflation rate turns out to be 8%, what is your revised estimate of the expected rate of return on the stock?
Expert Solution
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Step1 Concept |
The concept of this question belongs to arbitrage pricing theory model which has a general assumption that prices ,returns are affected by various factors like inflation,GNP(gross national product etc.) |
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Step2 Formula equation |
Revised return=Expected return of stock+ beta*Factor1+ beta *factor2 Factor (in this question)=actual rate-expected rate |
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Step3 Understand the question |
2 factors are given
Expected Return=12% |
Step4
Solution
Revised Estimate = 0.12 + [1*(0.05-0.02)] + [0.5 * (0.08-0.05)]
Revised Estimate: 0.12+ [(1*.02) + (0.5*.03)] = .155 or 15.5%
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