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3 February, 11:26

Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.45 on factor 1, and a beta of. 86 on factor 2. The risk premium on the factor 1 portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on factor 2 if no arbitrage opportunities exist?

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  1. 3 February, 11:42
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    The risk premium on factor 2 = 9.26%.

    Explanation:

    Let us denote the risk premium of factor 2 as x

    Below is the formula we can use to calculate the risk premium of factor 2.

    Expected return on stock = (Beta (factor 1) * expected return of 1) + (beta of 2x * risk free reate)

    17.6% = (1.45*3.2%) + 0.86x+5%

    17.6 = 4.64 + 0.86x+5%

    17.6 - 4.64 - 5 = 0.86x

    7.96 = 0.86x

    x = 7.96/0.86 = 9.2558

    The risk premium on factor 2 = 9.26%.
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