Suppose that the market can be described by the following four sources of systematic risk...
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Finance
Suppose that the market can be described by the following four sources of systematic risk with associated risk premiums:
| Factor | Risk Premium of a factor portfolio (%) |
| Industrial Production (I) | 4 |
| Interest rates (R) | 5 |
| Consumer condence (C) | 2 |
| Inflation rate (F) | 3 |
The return on a particular welldiversied portfolio is generated according to the following equation
rP = 10% + 2I + 1R + 0.5C+1.2F
where I, R, C, and F are unanticipated components in Industrial Production, Interest rates, Consumer condence, and inflation rate, respectively. The Tbill rate is 3%
- Find the ecient rate of return of this portfolio using the APT.
- Is the stock over or under- priced? Explain.
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