M&B3 3rd Edition by Dean Croushore

Exercise 8

Suppose that the following version of the APT is a good model of risk in the stock market. Consider three factors: the stock market's excess return in percentage points, the change over the last year in the price of oil in dollars, and the spread between 10-year Treasury bonds and three-month Treasury bills in percentage points. Suppose that the stock market's average excess return is 9 percent and that the average risk-free interest rate is 1 percent, the average change in the price of oil is $0.25, and the average spread between 10-year Treasury bonds and threemonth Treasury bills is 1.25. Each of the following stocks has the beta coeffi cients shown in the table below:
a What is the expected return to each of the three stocks
b If the market's excess return were to be above average by 1 percent (that is, it rose 10 percent in a particular year instead of the usual 9 percent), what would you expect the effect to be on the return to each of the three stocks
c If the price of oil were to fall by $3.00 in a particular year (that is, $3.25 less than the average change of _$0.25), what would you expect the effect to be on the return to each of the three stocks
d If the interest-rate spread rose to 2.00 percent in a particular year (that is, 0.75 percentage point higher than average), what would you expect the effect to be on the return to each of the three stocks