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%).