A researcher has determined that a two-factor model is appropriate to determine

Question

A researcher has determined that a two-factor model is appropriate to determine the return on a stock. The factors are the percentage change in GNP and an interst rate. GNP is expected to grow by 3.6%, and the interest rate is expected to be 3.1%. A stock has a beta of 1.4 on the percentage change in GNP and a beta of -.53 on the interest rate. If the expected rate of return on the stock is 11.5%,, what is the revised expected return on the stock if GNP actually grows by 3.2% and the interest rate is 3.4%?

Explanation / Answer

Return of stock=Risk free rate +beta of GNP*GNP+=beta of interest*Interest rate 11.5=Risk free rate +1.4*3.6+(-.53*3.1) Risk free rate= 11.5-1.4*3.6+.53*3.1 Risk free rate= 8.103% New Return of stock=Risk free rate +beta of GNP*GNP+=beta of interest*Interest rate New return=8.103+1.4*3.2+(-.53*3.4) New return= 10.781%

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