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Suppose a three-factor model is appropriate to describe the returns of a stock
Suppose a three-factor model is appropriate to describe the returns of a stock. Information about those three factors is presented in the following chart:
Factorβ Expected Value Actual Value
GDP. .0007541 $14,101 $14,078
Inflation −.96 3.0% 2.8%
Interest rates −.38 5.4% 5.2%
a.What is the systematic risk of the stock return? (A negative answer should be indicated by a negative sign. Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.Suppose unexpected bad news about the firm was announced that causes the stock price to drop by 1.3 percent. If the expected return on the stock is 13.0 percent, what is the total return on this stock? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Expert Solution
a) Computation of systematic risk of the stock return:
Systematic Risk of the Stock Return = 0.0007541*(14078-14101) - 0.96*(2.8%-3%) - 0.38*(5.2%-5.4%)
= -0.01734+0.00192+0.00076
Systematic Risk of the Stock Return = -0.0147 or -1.47%
b) Computation of Total Return on Stock:
Total Return of Stock = Expected Return + Systematic Risk - Drop in Price
= 13% -1.47% - 1.3%
Total Return of Stock = 10.23%
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