Describe the returns on common stocks

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Consider an economy where two factors are sufficient to describe the returns on common stocks. Stated formally, we have: E(ri)=rf+bi,1 f1+bi,2 f2, The following table gives the estimated sensitivities of stocks A and B to the two factors, as well as their expected returns. Stock , , A 0.7 1.4 12.7% B 2.1 0.7 17.6% The risk-free rate of return is 5%. Suppose A and B are priced consistently with the two-factor APT above. (a) Calculate the risk premiums of the two factors ( and ). (b) Suppose there is another stock, C with sensitivities , = 0.3 and , = 0.8. Your analysis shows that holding c your expected return will be 10%. Is c is overvalued, undervalued or correctly priced based on APT?

Reference no: EM131883681

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