Consider the multifactor APT with two factors. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 6%, respectively. Stock A has a beta of 1.2 on factor-1, and a beta of 0.7 on factor-2. The expected return on stock A is 17%. If no arbitrage opportunities exist, the risk-free rate of return is
A) 6.0%.
B) 6.5%.
C) 6.8%.
D) 7.4%.

Question

Quizplus · Accepted Answer

The expected return on stock A can be calculated using the APT formula: Expected Return = Risk-free rate + (Beta1 * Risk Premium1) + (Beta2 * Risk Premium2). Plugging in the values: 17% = Risk-free rate + (1.2 * 5%) + (0.7 * 6%). Solving for the risk-free rate gives 6.8%.

Consider the Multifactor APT with Two Factors