Question

Suppose Carz common stock has a market factor beta of .9, the risk-free rate is 3.5 percent, inflation is expected to be 2.6 percent, and the expected market risk premium is 7.2 percent. What is the expected return based on the one-factor arbitrage pricing model?

Answer 1

Answer:

The question is missing below options:

a.13.05%

b.9.98%

c.7.72 %

d.12.32%

e.12.58%

The correct option is B,9.98%

Explanation:

A one-factor arbitrage pricing model is equivalent capital asset pricing model since the market beta is only one provided,hence the formula for capital asset pricing model is given as:

E(R)=Rf+β(Rm-Rf)

E(R)=expected  return =unknown

Rf =risk free rate =3.5%

R(m)=market rate

(Rm-Rf)=market risk premium=7.2%

β=volatility of return=0.9

Hence

E(R)=3.5%+0.9(7.2%)

E(R)=3.5%+6.48 %

E(R)=9.98%

Hence, the premium expected on this stock over and above the government risk free rate of return is 6.48%.

This implies that investor is compensated with additional rate due to risks he could suffer from investing in the company as against investing in government's securities where it is guaranteed that the sum invested and the interest thereon will be paid as government has access to large of funds.