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1) Let a three-factor APT model. Factors and associated risk premiums are

Factor Risk Premium
Change in GNP 5%
Change in energy prices -1
Change in long-term interest rates +2

Compute expected rates of return on given stocks. Risk-free interest rate= 7%.

a) Stock whose return is uncorrelated with all 3 factors.

b) Stock with average exposure to each factor (that is, with b = 1 for each).

c) A pure-play energy stock with high exposure to energy factor ( b = 2) but zero exposure to the other two factors.

d) The aluminium company stock with the average sensitivity to changes in interest rates and GNP, but negative exposure of b = - 1.5 to energy factor. (Aluminium Company is energy-intensive and suffers when energy prices increase.)

2) A ten-year Japanese government bond with the face value of= ¥50,000 pays the coupon= 5.5% (2.75% of face value every six months).  The semi-annually compounded interest rate is= 5.2% (a six month discount rate= 5.2/2 = 2.6%).

Basic Finance, Finance

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