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Determining the Rates of Return

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You live in Detroit, MI, the headquarters for many U.S. auto manufacturers, and work for one of them. Analysts have determined that rates of return on securities are better explained by multifactor models, and that the rate of return of a portfolio of U.S. auto manufacturers is explained as: please see attachment.

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PORTFOLIO CONSTRUCTION

Assumptions:

1. The investor works in an auto manufacturer.
2. He saves a certain amount every year.
3. Rates of return on all assets are explained by the factors as indicated by the model:

Rate of return of a portfolio (rA) = rf + 3.1 Y -2.5 G -1.2 I + u

Where rf = risk-free rate; Y=national income; G=price of gasoline; I= interest rate on car loans; u =residual error of regression (random)

Required:

Portfolio Construction

The model upon which rate of return computation is anchored indicates that the individual's rate of return of the portfolio of his investment will be affected by the following factors:
1. Risk-free rate
The higher the risk-free rate; the higher the rate of return of the portfolio.
2. National income
The higher the national income; the higher the return of the portfolio
3. Price of gasoline
The higher the price of gasoline; the lower the return of the portfolio.

4. Interest rate on loans
The higher the interest rate on loans; the lower the rate of ...

Solution Summary

The solution determines the rates of return.

$2.19