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Do I substitute the numbers into the formula? Consider a two factor economy. Assume the risk-free rate = 3%, and the risk premiums are RP

Do I substitute the numbers into the formula?

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:

rABC.08-0.55F1+1.2F2+eABC

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

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

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