Question
17. Suppose that we have identified two important systematic risk factors: the growth rate of gross domestic product, labeled GDP, and the 30-year bond interest
17. Suppose that we have identified two important systematic risk factors: the growth rate of gross domestic product, labeled GDP, and the 30-year bond interest rate, labeled BR. Whole Hog Farms, Inc. has a beta 1.1 on GDP and 0.9 on BR. Whole Hog has an expected stock return of 12%. GDP is expected to be 5.5% and BR 6%. If gross domestic product grows by 3% and the 30-year bond rate turns out to be 9%, and no unexpected news specifically concerning Whole Hog occurs, within the Arbitrage Pricing Theory framework, what is your best guess for the realized rate of return on Whole Hog stock?
18. Assume two factors have been identified as the important sources of systematic risk: the growth rate in industrial production, IP, and the rate of change in the price of West Texas crude oil, OIL. Suppose also that the expected return on a well-diversified IP factor portfolio, E(rIP) is 8% and E(rOIL) is 12%. Now consider the Low Ride Automobile Co. with ?IP = 1.3 and ?OIL = -0.2. Assume rf = 6%. Within an Arbitrage Pricing Theory framework, what is the fair rate of return on Low Ride?
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