You are planning to buy a stock, the risk on which is dependent on two factors: (1) the change over the last year in the inflation rate and (2) the spread between ten-year Treasury bonds and three-month Treasury bills.Suppose the average risk-free interest rate is 1 percent.The beta coefficients of the stock associated with the change in inflation rate and spread between ten-year Treasury bonds and three-month Treasury bills are -2 and 5 respectively.If you expect the inflation rate to rise 1 percentage point and you think the spread will be 3 percentage points.What is the expected return to this stock? Use the arbitrage-pricing theory.

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Quizplus · Accepted Answer

The expected return is calculated using the formula: Expected Return = Risk-free rate + (Beta1 * Factor1) + (Beta2 * Factor2). Here, Expected Return = 1% + (-2 * 1%) + (5 * 3%) = 1% - 2% + 15% = 14%.

You Are Planning to Buy a Stock, the Risk on Which