Exhibit 7-9
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Stocks A, B, and C have two risk factors with the following beta coefficients. The zero-beta return (λ 0 ) = .025 and the risk premiums for the two factors are (λ 1 ) = .12 and (λ 0 ) = .10.
$\begin{array}{ccc}
\text { Stock } & \text { Factor } 1 b_{i l} & \text { Factor } 2 b_{i 2} \
\hline \text { A } & -0.25 & 1.1 \
\text { B } & -0.05 & 0.9 \
\text { C } & 0.01 & 0.6
\end{array}$
-Refer to Exhibit 7-9. Assume that stocks A, B, and C never pay dividends and stocks A, B, and C are currently trading at $10, $20, and $30, respectively. What is the expected price next year for each stock? $\begin{array}{lccc}
& A & B & C \
\hline \text { I. } & \$ 10.82 & \$ 21.82 & \$ 30.99 \
\text { II. } & \$ 11.05 & \$ 22.18 & \$ 30.96 \
\text { III. } & \$ 11.32 & \$ 22.56 & \$ 30.99 \
\text { IV. } & \$ 11.65 & \$ 22.42 & \$ 30.96 \
\text { V. } & \$ 18.50 & \$ 37.00 & \$ 48.30
\end{array}$
A) I
B) II
C) III
D) IV
E) V

Question

Exhibit 7-9
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Stocks A, B, and C have two risk factors with the following beta coefficients. The zero-beta return (λ 0 ) = .025 and the risk premiums for the two factors are (λ 1 ) = .12 and (λ 0 ) = .10.
 $\begin{array}{ccc}
\text { Stock } & \text { Factor } 1 b_{i l} & \text { Factor } 2 b_{i 2} \
\hline \text { A } & -0.25 & 1.1 \
\text { B } & -0.05 & 0.9 \
\text { C } & 0.01 & 0.6
\end{array}$
-Refer to Exhibit 7-9. Assume that stocks A, B, and C never pay dividends and stocks A, B, and C are currently trading at $10, $20, and $30, respectively. What is the expected price next year for each stock? $\begin{array}{lccc} 
& A & B & C \
\hline  \text { I. } & \$ 10.82 & \$ 21.82 & \$ 30.99 \
\text { II. } & \$ 11.05 & \$ 22.18 & \$ 30.96 \
\text { III. } & \$ 11.32 & \$ 22.56 & \$ 30.99 \
\text { IV. } & \$ 11.65 & \$ 22.42 & \$ 30.96 \
\text { V. } & \$ 18.50 & \$ 37.00 & \$ 48.30
\end{array}$
A) I
B) II
C) III
D) IV
E) V

Quizplus · Accepted Answer

The expected return for each stock can be calculated using the formula: Expected Return = Zero-beta return + (Beta Factor 1 * Risk Premium 1) + (Beta Factor 2 * Risk Premium 2). For Stock A: Expected Return = 0.025 + (-0.25 * 0.12) + (1.1 * 0.10) = 0.025 - 0.03 + 0.11 = 0.105 or 10.5%. For Stock B: Expected Return = 0.025 + (-0.05 * 0.12) + (0.9 * 0.10) = 0.025 - 0.006 + 0.09 = 0.109 or 10.9%. For Stock C: Expected Return = 0.025 + (0.01 * 0.12) + (0.6 * 0.10) = 0.025 + 0.0012 + 0.06 = 0.0862 or 8.62%. Calculating the expected price next year: For Stock A: $10 * (1 + 0.105) = $11.05. For Stock B: $20 * (1 + 0.109) = $22.18. For Stock C: $30 * (1 + 0.0862) = $30.96.

Exhibit 7-9 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)

Exhibit 7-9
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)