Part A 1. The estimated betas for AOL Time Wamer (NYSE: AOL), J.P. Morgan Chase

Question

Part A 1. The estimated betas for AOL Time Wamer (NYSE: AOL), J.P. Morgan Chase & Company (NYSE: JPM), and The Boeing Company (NYSE: BA) are 2.40 1.70, and 0.90, respectively. The risk-free rate of return is 4.35 percent and the equity risk premium is 8.04 percent. Calculate the required rates of return for these three stocks using the CAPM 2. The estimated factor sensitivities of TerraNova Energy to Fama-French factors and the risk premia associated with those factors are given in the following Table: Factor sensitivity Risk Premium (%) 4.6 2.8 4.4 Market factor 1.25 Size factor 0.6 Value factor -0.2 Based on the Fama-French model, calculate the required return for TerraNova Energy using these estimates. Assume that the Treasury bill rate is 4.7 percent A. B. Describe the expected style characteristics of TerraNova based on its factor sensitivities

Explanation / Answer

Required rate of return =risk free rate +brta*risk premium

AOL=4.35+2.4*8.04= 23.65%

JPM =4.35*+1.7*8.04=18.02%

BA =4.35+0.90*8.04=11.57%

2. Required rate of return =risk free rate +factor sensitivity 1*risk premium +factor sensitivity 2*risk premium +factor sensitivity 3*risk premium

=4.7+(1.25*4.6)+(-0.6*2.8)+(-0.2*4.4)

=4.7+5.75-1.68+0.88

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