CA Final · Advanced Financial Management · Portfolio Management
Under a two-factor APT model, the risk-free rate is 6%. Factor 1 (industrial output) has a risk premium of 4% and factor 2 (interest-rate movement) has a risk premium of 3%. Equity share of Kaveri Textiles has sensitivities of 1.2 to factor 1 and 0.5 to factor 2. What is the share's required return under APT?
The required return is 12.3%. APT adds to the risk-free rate each factor's risk premium multiplied by the share's sensitivity to that factor: 6% + 1.2×4% + 0.5×3% = 12.3%.
- A12.3%Correct
- B6.3%
- C9.3%
- D13.0%
Explanation
APT return = Rf + b1×RP1 + b2×RP2 = 6 + 1.2×4 + 0.5×3 = 6 + 4.8 + 1.5 = 12.3%. Option 13.0% adds the raw premiums (6+4+3) without weighting them by the sensitivities. Option 9.3% wrongly subtracts the second factor's contribution.
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