1. You believe that three risk factors drive share market returns: unexpected ch
ID: 2614715 • Letter: 1
Question
1. You believe that three risk factors drive share market returns: unexpected changes in oil prices, unexpected shift in GDP, and unexpected movement in the overall share market. The risk premium for bearing oil-price risk is 4 percent, the risk premium for bearing GDP risk is 5 percent, and the risk premium for bearing market risk is 6 percent. A particular company’s fortunes are very sensitive to oil prices, meaning that its “oil price beta” is 2.0. Its GDP beta is 0.50, and its market beta is 1.0. If the risk-free rate is 3 percent, what is the expected return on this share? (5)
Explanation / Answer
Expected Return = Risk free rate + {[Oil price Beta*RP of Oil price risk]+[GDP beta*RP of GDP risk]+[Market Beta*RP of bearing Market risk]}
=3 %+{ [4%*2] + [5%*0.50] + [6%*1]}
= 3% +{16.5}
= 19.5%
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