Financial Risk Manager Part 1

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The common stock of Swisscom Inc. is examined with a single factor model using unexpected percent changes in GDP as the single factor. You have been provided with the following data:

Expected return for Swisscom = 10%
GDP factor-beta = 2
Expected GDP growth = 2%

Revised macroeconomic information strongly suggests that the GDP will grow by a whopping 5% as opposed to the original prediction of 2%. Assuming there's no new information regarding firm-specific events, calculate the revised expected return using a single factor model.

Other

Community

TTanishq

10.6%

20%

16%

Explanation:

Explanation

The equation for a single factor model for stock i is given by:

$R_i = E(R_i) + \beta_{i,j} F_j + e_i$

Where:

$R_i$ = revised return for stock i
$E(R_i)$ = the expected return for stock i
$\beta_{i,j}$ = the jth factor beta for stock i
$F_j$ = the deviation of the factor j from its expected value
$e_i$ = the firm-specific return for stock i

Given data:

$E(R_i) = 10\% = 0.10$
$\beta_{i,j} = 2$
Expected GDP growth = 2% = 0.02
Actual GDP growth = 5% = 0.05
$F_j = 0.05 - 0.02 = 0.03$ (unexpected GDP growth)
$e_i = 0$ (no new firm-specific information)

Calculation: $R_i = 0.10 + 2(0.05 - 0.02) = 0.10 + 2(0.03) = 0.10 + 0.06 = 0.16 \text{ or } 16\%$

Therefore, the revised expected return is 16%._

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