Suppose that the market can be described by the following three sources of syste

Question

Suppose that the market can be described by the following three sources of systematic risk with associated risk premiums. Factor Industrial production (I) Interest rates (R) Consumer confidence (C) Risk Premium 6% 2 The return on a particular stock is generated according to the following equation r: 15% + 1.0, + O.5R + 0.75C+ e a-1. Find the equilibrium rate of return on this stock using the APT. The T-bill rate is 6%. (Do not round intermediate calculations.) Equilibrium rate of return a-2. Is the stock over-or underpriced? Underpriced Overpriced

Explanation / Answer

We now calculate the equilibrium rate of return using APT of the concerned stock using the sensitivities and their risk premiums and the risk free rate(Treasury bill rate) mentioned above.

Equilibrium rate of return = Rf + 1*6% + 0.5*2% + 0.75*4

= 16%

Here, Equilibirum return(16%) of the stock using APT is greater than expected return which is 15% as mentioned in the equation mentioned above.

Hence, it can be concluded that the stock is overpriced.

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