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You are exploring the use of APT in making investment choices. You have identified three...

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Accounting

You are exploring the use of APT in making investment choices. You have identified three factors labelled F1, F2, and F3 with corresponding risk premia RP1 = 3%, RP2 = 6%, and RP3 = 2%.

A stock with ticker ABC has historically shown returns which have followed the equation:

rABC=0.14+.50F1+1.20F2+.8F3+eABC

What is the equilibrium rate of return for stock ABC using the APT, if the T-bill rate is 5%?

If the price of stock ABC is $21, do you conclude that it is underpriced or overvalued? Explain your reasoning fully.

If the expected price next year will be $23, what is the fair price today, that is, the stock price now that will not allow for arbitrage profits?

Assume that the T-bill rate decreases to 3%, with the other variables remaining unchanged. Would you recommend to buy or sell stock ABC?

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