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CMA Final · Strategic Financial Management · Asset Pricing Theories

A two-factor APT model gives a risk-free rate of 5%, a risk premium of 4% for factor 1 (inflation surprise) and 3% for factor 2 (GDP growth). A stock has sensitivities of 1.5 to factor 1 and 0.8 to factor 2. What is its expected return under APT?

The expected return is 13.4%. APT adds to the risk-free rate each factor sensitivity multiplied by its risk premium: 5% plus 1.5 times 4% plus 0.8 times 3%. That is 5 plus 6 plus 2.4, giving 13.4%.

  1. A13.4%Correct
  2. B11.0%
  3. C8.4%
  4. D12.4%

Explanation

Expected return = 5 + 1.5 x 4 + 0.8 x 3 = 5 + 6 + 2.4 = 13.4%. The 8.4% option omits the risk-free rate. The 12.4% option mistakenly uses 0.8 x 2.

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