Research has identified two systematic factors that affect U.S.stock returns.The factors are growth in industrial production and changes in long term interest rates.Industrial production growth is expected to be 3% and long term interest rates are expected to increase by 1%.You are analyzing a stock is that has a beta of 1.2 on the industrial production factor and 0.5 on the interest rate factor.It currently has an expected return of 12%.However,if industrial production actually grows 5% and interest rates drop 2% what is your best guess of the stock's return?
A) 15.9%
B) 12.9%
C) 13.2%
D) 12.0%

Question

Quizplus · Accepted Answer

Using the information provided, we can calculate the expected return as follows:
Expected return = 12% + (1.2 x 2%) - (0.5 x 1%) + (1.2 x 2%) = 12.9%
(1.2 x 2%) represents the effect of the 2% increase in industrial production growth, and (0.5 x 1%) represents the effect of the 1% decrease in long term interest rates. Adding these two factors to the stock's initial expected return of 12%, and subtracting the effect of the interest rate increase (1.2 x 2%), we arrive at an expected return of 12.9%. Therefore, the correct choice is B.

Research Has Identified Two Systematic Factors That Affect U