Suppose that we have identified three important systematic risk factors given by exports,inflation,and industrial production. In the beginning of the year,growth in these three factors is estimated at -1%,2.5%,and 3.5% respectively. However,actual growth in these factors turns out to be 1%,-2%,and 2%. The factor betas are given by β_EX = 1.8,β_I = 0.7,and β_IP = 1.0. If the expected return on the stock is 6%,and no unexpected news concerning the stock surfaces,calculate the stock's total return. A) 2.95% B) 4.95% C) 6.55% D) 7.40% E) 8.85%

Question

Quizplus · Accepted Answer

The total return is calculated by adjusting the expected return with the impact of unexpected changes in the factors. The unexpected changes are 2% for exports, -4.5% for inflation, and -1.5% for industrial production. The total impact is (1.8 * 2%) + (0.7 * -4.5%) + (1.0 * -1.5%) = 3.6% - 3.15% - 1.5% = -1.05%. The total return is 6% - 1.05% = 4.95%.

Suppose That We Have Identified Three Important Systematic Risk Factors