Scribd
Upload
1K views3 pages

Ex 1

The document provides stock return information for three securities (A, B, C) across three possible states of industrial production growth (Ugly, Bad, Good). It asks to: 1) Calculate the unanticipated growth shocks across states. 2) Determine the expected returns and betas for each security. 3) Using securities A and B, calculate the implied risk-free rate and factor premium. 4) Using securities A and C, also calculate the risk-free rate and factor premium. 5) There is an arbitrage opportunity since the calculations in steps 3) and 4) yield different factor premiums.

Uploaded by

Adahyl Garcez
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
1K views3 pages

Ex 1

The document provides stock return information for three securities (A, B, C) across three possible states of industrial production growth (Ugly, Bad, Good). It asks to: 1) Calculate the unanticipated growth shocks across states. 2) Determine the expected returns and betas for each security. 3) Using securities A and B, calculate the implied risk-free rate and factor premium. 4) Using securities A and C, also calculate the risk-free rate and factor premium. 5) There is an arbitrage opportunity since the calculations in steps 3) and 4) yield different factor premiums.

Uploaded by

Adahyl Garcez
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 3

1.

Use the following facts for (all parts of) this problem:

• There is only one factor that affects stock returns, and it is the growth in industrial production

• There are three possible states of the world: Ugly, Bad and Good. We know exactly how much
return the following three securities (A, B and C) will yield in each of the possible states:

State Ugly Bad Good

Probability 1/3 1/3 1/3

Growth in production 0% 5% 10%

Stock A 16% 6% -4%

Stock B 4% 9% 14%

Stock C 2% 12% 22%

• Securities A, B and C sell for 50 rupees each

(a) Calculate the values of F (unanticipated growth in industrial production) for the only factor in all
three states

(b) Calculate from the above table, the expected returns of each of the three securities, and their
factor sensitivities to the industrial production factor

(c) Using only securities A and B, calculate the implied risk-free rate, and the factor premium for the
industrial production factor

(d) Now, using only securities A and C, calculate the implied risk-free rate, and the factor premium
for the industrial production factor

(e) Comparing your answers from (c) and (d) above, is there an arbitrage opportunity in this
economy?

(15 points)
Answear :

a)

State Ugly Bad Good


Growth in
0% 5% 10%
production
Expected Growth 0.00% 1.67% 3.33%
Unantecipated
0.00% 3.33% 6.67%
shock

b)

Multiplying the return in each state by its probability and calculating the betas we have

Ugly Bad Good Total Beta


Stock A 5.33% 2.00% -1.33% 6.00% -2
Stock B 1.33% 3.00% 4.67% 9.00% 1
Stock C 0.67% 4.00% 7.33% 12.00% 2

c)

Return = Rf + Beta * RFP

0.06 = Rf – 2 * RFP

0.09 = RF + 1 * RFP

Solving these equations we get :

RFP = 0.01 and Rf = 0.08

d)

0.06 = Rf – 2* RFP

0.12 = Rf + 2 * RFP

Solving these equations we get:

RFP = 0.02 and Rf = 0.08

e)
Yes there is an arbitrage opportunity since we get different RFPs.

You might also like