FRM Part I · FRM Exam Part I · The Arbitrage Pricing Theory and Multifactor Models of Risk and Return
A single-factor APT holds. The risk-free rate is 3% and the factor risk premium is 5%. Stock A has a factor beta of 1.2. What is the expected return on Stock A?
The expected return is 9%. Under a single-factor APT, it equals the risk-free rate plus beta times the factor risk premium: 3% plus 1.2 times 5%, which is 3% plus 6%.
- A6.0%
- B8.0%
- C9.0%Correct
- D11.0%
Explanation
E(R) = Rf + beta x premium = 3% + 1.2 x 5% = 3% + 6% = 9%. Choosing 6% omits the risk-free rate. Choosing 8% uses a beta of 1. Choosing 11% wrongly adds the beta to the premium.
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