Suppose that we have identified three important systematic risk factors given by

Question

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 EX = 1.8, I = 0.7, and IP = 1.0. Calculate the stock's total return if the company announces that an important patent filing has been granted sooner than expected and will earn the company 5% more in return.

Explanation / Answer

In the absence of original expected return, assume it is 6%.

New expected return:

= 6%+1.8×(0.01-(-0.01))+0.7×(-0.02-0.025)+1×(0.02-0.035)+0.05

= 0.06+1.8×(0.02)+0.7×(-0.045)+1×(-0.015)+0.05

= 0.0995 or 9.95%

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