Suppose stock returns can be explained by the following three-factor model Assum

Question

Suppose stock returns can be explained by the following three-factor model Assume there is no firm-specific risk. The information for each stock is presented here 2 1.10 1.70 -.47 3 Stock A Stock B Stock C 2.10 90 90 85 30 1.56 The risk premiums for the factors are 7.8 percent, 7 percent, and 7.4 percent, respectively. You create a portfolio with 30 percent invested in Stock A, 30 percent invested in Stock B, and the remainder in Stock C What is the expression for the return on your portfolio? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Factor Beta Factor F1 Factor F2 Factor F3 1.26 65 79 If the risk-free rate is 4.9 percent, what is the expected return on your portfolio? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Expected return

Explanation / Answer

Factor F1 = 0.3*2.1 + 0.3*0.9 + 0.4*0.9 = 1.26

Factor F2 = 0.3*1.1 + 0.3*1.7 + 0.4*(-0.47) = 0.65

Factor F3 = 0.3*0.85 + 0.3*(-0.3) + 0.4*1.56 = 0.79

Expected return = 4.9% + 1.26*7.8% + 0.65*7% - 0.79*7.4%

   = 13.43%

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