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CMA Intermediate · Financial Management and Business Data Analytics · Risk and Return

Under a two-factor APT model, the risk-free rate is 6%, the risk premium for inflation-surprise factor is 3% and for industrial-production factor is 5%. Shares of Kaveri Textiles have sensitivities of 1.2 to inflation and 0.8 to industrial production. The expected return is:

The expected return is 13.6%. Add the risk-free rate of 6% to the inflation component (1.2 × 3% = 3.6%) and the industrial production component (0.8 × 5% = 4%). Each factor premium is multiplied by its sensitivity under APT.

  1. A13.6%Correct
  2. B12.0%
  3. C9.6%
  4. D15.0%

Explanation

E(R) = 6% + 1.2×3% + 0.8×5% = 6 + 3.6 + 4.0 = 13.6%. Option 9.6% omits the risk-free rate (3.6+4.0=7.6 is not it, and 6+3.6 = 9.6 ignores the second factor).

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