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%
E) none of these

Question

Quizplus · Accepted Answer

According to the APT, the expected return of a stock can be calculated as:

Expected return = Risk-free rate + (Beta1 x Risk premium on factor 1) + (Beta2 x Risk premium on factor 2)

Substituting the given values, we get:

17% = Risk-free rate + (1.2 x 5%) + (0.7 x 6%)

Solving for the risk-free rate, we get:

Risk-free rate = 6.8%

Therefore, the correct answer is C) 6.8%.

Consider the Multifactor APT with Two Factors