Suppose two factors are identified for the U.S. economy: the growth rate of indu

Question

Suppose two factors are identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 5% and IR 6%. A stock with a beta of 1 on IP and 0.5 on IR currently is expected to provide a rate of return of 11%. If industrial production actually grows by 6%, while the inflation rate turns out to be 8%, what will be your expected rate of return on the stock, given the new information about the industrial production rate and the inflation rate? (Enter your answer as a percentage rounded to 1 decimal places.)

Suppose two factors are identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 5% and IR 6%. A stock with a beta of 1 on IP and 0.5 on IR currently is expected to provide a rate of return of 11%. If industrial production actually grows by 6%, while the inflation rate turns out to be 8%, what will be your expected rate of return on the stock, given the new information about the industrial production rate and the inflation rate? (Enter your answer as a percentage rounded to 1 decimal places.)

Explanation / Answer

expected return = risk free rate + IP beta * IP growth + Inflation beta* inflation growth

Risk free rate = 11 - 1 * 5 - 0.5* 6 = 3%

expected return in scenario 2 = risk free rate + IP beta * IP growth + Inflation beta* inflation growth

= 3 + 1*6 + 0.5*8 = 13%

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