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    Equilibrium rate of return using APT

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    1. Suppose the market can be described by the following three sources of systematic risk with associated risk premiums.

    Factor Risk Premium
    Industrial production (I) 7%
    Interest rates ( R) 3
    Consumer confidence ( C) 5

    The return on a particular stock is generated according to the following equation:
    R = 10% + 1.5 I + 0.6 R + .70 C + e
    Find the equilibrium rate of return on this stock using the APT. The T-bill rate is 5%.
    Is the stock over- or under-priced? Explain.

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    Solution Preview

    Under APT
    Equilibrium return = Risk free rate + 1.5 I + 0.6 R + .70 C
    Equilibrium return = 5% + 1.5 ...

    Solution Summary

    The solution explains how to calculate the equilibrium rate of return using APT.