Suppose that the expected return on the stock using a two-factor model is 11%. You have some updated information about the two factors, which is shown in the table. Calculate the stock’s actual return if the company-specific surprise for the year is 3%.

Variable

Actual Value (%)

Expected Value (%)

Stock’s Factor Sensitivity

Change in interest rate

2.0

0.0

-1.5

Growth in GDP

1.0

4.0

2.0

Note: you can solve this question without any calculation.

Click to Access Spreadsheet

Q23.xlsx
Download Q23.xlsx

Question

Suppose that the expected return on the stock using a two-factor model is 11%.  You have some updated information about the two factors, which is shown in the table.  Calculate the stock’s actual return if the company-specific surprise for the year is 3%.

Variable

Actual Value (%)

Expected Value (%)

Stock’s Factor Sensitivity

Change in interest rate

2.0

0.0

-1.5

Growth in GDP

1.0

4.0

2.0

Note: you can solve this question without any calculation.

Click to Access Spreadsheet

Q23.xlsx
Download Q23.xlsx

BlackTom AI · Accepted Answer

To tackle this two-factor model question, I’ll lay out the given data and then examine how each option would arise from the model’s components.
First, the baseline: the stock’s expected return based on the two-factor model is 11%. This is the starting point before any new information or surprises are incorporated.
Option-by-option examination:
- Option 7.6%: This would require adding 0.6 percentage points of return beyond the baseline after accounting for factor surprises and the company-specific surprise. If we apply the factor surpluses using the sensitivities: the interest-rate surprise is actual 2.0 versus expected 0.0, so the surprise is +2.0; multiply by the stock’s sensitivity to that factor: -1.5 × (+2.0) = -3.0 percentage points. The GDP growth surprise is actual 1.0 versus expected 4.0, a surprise of -3.0; multiply by 2.0 sensitivity: 2.0 × (-3.0) = -6.0 percentage points. The total from factor surprises would be -3.0 + (-6.0) = -9.0. Starting from 11%, that yields 2.0% before the company-specific surprise. If the company-specific surprise is +3.0%, the final would be 2.0% + 3.0% = 5.0%. Thus 7.6% cannot be obtained from these numbers.
- Option 5.0%: This exactly matches the calculation above. After applying the two factor surprises (-9.0 points total) to the 11% baseline, we get 2.0%, and adding the 3% company-specific surprise yields 5.0%. This aligns with the arithmetic of the supplied data.
- Option 6.2%: To reach 6.2%, the combination of factor-surprise effects plus the company-specific surprise would need to sum to 6.2% above the baseline, or a substantial deviation from the computed -9.0 net factor effect, which isn’t supported by the given sensitivities and surprises.
- Option 5.4%: This would require a final total of 5.4%. With the factor-effect sum pegged at -9.0 and the company surprise at +3.0, the total is 5.0%. Getting 5.4% would require a different set of surprises or sensitivities not provided, so it’s inconsistent with the provided numbers.
- Option 7.3%: Achieving 7.3% would demand a sizable positive adjustment after the factor effects, which contradicts the negative net factor contribution (-9.0) shown by multiplying the sensitivities by the given surprises. The data don’t support a net rise to 7.3%.
In summary, when you apply the observed changes in the two factors to the stock using the specified sensitivities, the factor-driven change is -9.0 percentage points. Adding this to the baseline 11% gives 2.0%. The 3% company-specific surprise then raises the total to 5.0%. The other options would require alternative numbers or interpretations not supported by the given table and instructions.

View Explanation

Log in for full answers

Similar Questions

If the Fama-French factor model is absolutely correct, which of the following is not true?

Which statement about the Fama-French five factors is FALSE?

The Hou, Xue, and Zhang q-factor model...

In the Fama-French three-factor model, which is NOT a factor?

Suppose that the market expects the values for the three macro factors given in column 1 below, but that the actual values turn out as given in column 2. What is the revised expectations for the rate of return on the stock once the “surprises” become known?

In a consumer society, many adults channel creativity into buying things

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler