Consider a two factor economy. Assume the risk-free rate = 3%, and the risk premiums are RP₁ = 10%, RP₂ = 8%. The return on stock ABC is generated according to the following equation:

r_ABC=0.08-0.55F₁+1.2F₂+e_ABC

Assume that the stock is currently priced at $50 per share.

What is the expected return for stock ABC using the APT?

Is stock ABC underpriced or overvalued?

If the expected price next year will be $55, what is the stock price now that will not allow for arbitrage profits?

Assume that the risk free rate increases to 4%, with the other variables remaining unchanged.Would you recommend to buy or sell stock ABC?