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 turn out to be 1%, -2%, and
2%)The factor betas are given by bEX = 1.8, bI = 0.7, and bIP = 1.0.The expected return on the equity
Is 6%.What would the equity's total return be if the actual growth in each of the facts was equal to
Growth expected? Assume no unexpected news on the patent.
A)4%
B)5%
C)6%
D)7%
E)8%

Question

Quizplus · Accepted Answer

To calculate the equity's total return, we need to use the following formula:

Total Return = Expected Return + (Actual Growth - Expected Growth) x Factor Beta

For exports, the actual growth is higher than expected growth, so the equity's return will be:

Total Return = 6% + (1% - (-1%)) x 1.8 = 6% + 3.6% = 9.6%

For inflation, the actual growth is lower than expected growth, so the equity's return will be:

Total Return = 6% + (-2% - 2.5%) x 0.7 = 6% - 3.5% x 0.7 = 3.75%

For industrial production, the actual growth is equal to expected growth, so the equity's return will be:

Total Return = 6% + (2% - 3.5%) x 1.0 = 6% - 1.5% = 4.5%

To calculate the equity's total return under the assumption that the actual growth in each factor is equal to expected growth, we need to take the average of the three returns above:

Total Return = (9.6% + 3.75% + 4.5%) / 3 = 5.28%

However, since the question asks for the answer when actual growth is equal to expected growth, the correct answer is closest to the expected return, which is 6%. Therefore, the best choice is C) 6%.

Suppose That We Have Identiﬁed Three Important Systematic Risk Factors