Investors expect the market rate of return in the coming year to be 12%. The T-b

Question

Investors expect the market rate of return in the coming year to be 12%. The T-bill rate is 4%. Changing Fortunes Industries' stock has a beta of 0.5. The market value of its outstanding equity is $100 million. If the market return in the coming year actually turns out to be 10%. what is your best guess as to the rate of return that will be earned on Changing Fortunes' stock? Hint: Apply Arbitrage Pricing Theory (Lecture 6) to solve this problem. Your answer should be in percentage points and accurate to the hundredth. Question 9 1 pts Continue from Question 8. Suppose now that Changing Fortunes wins a surprising lawsuit during the year. Changing Fortunes' stock return during the year turns out to be 10%, what is your best guess as to the settlement amount won by Changing Fortunes?

Explanation / Answer

1) E(R) = 4+0.5(12-4)

       = 8%

If the market return s fall short by 2 % (10 % instead of 12%) then you will expect the rate of return on the stock to fall short by 0.5*2= 1%

Therefore, revised E(R) on the stock = 8-1=7%

2) Unexpected return earned due to lawsuit= 10-7=3%

Therefore, settlement amount as a result of lawsuit = 3% of $ 100 M= $ 3M

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