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Answer: 5.5%
## Explanation In Arbitrage Pricing Theory (APT), the expected return is calculated using the formula: **Expected Return = Risk-free rate + Σ(Beta_i × Risk Premium_i)** Given: - Risk-free rate = 2% - Factor betas and risk premiums: - Probability of default: Beta = 0.5, Premium = 2% - Daily trading volume: Beta = -0.2, Premium = -1% - Earnings growth forecast: Beta = 1.5, Premium = 1.5% **Calculation:** 1. Risk-free rate component: 2% 2. Probability of default component: 0.5 × 2% = 1% 3. Trading volume component: -0.2 × (-1%) = 0.2% 4. Earnings growth component: 1.5 × 1.5% = 2.25% **Total expected return:** 2% + 1% + 0.2% + 2.25% = 5.45% ≈ **5.5%** Therefore, the correct answer is **C. 5.5%**.
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Using an arbitrage pricing theory (APT) model, what is the expected return for a stock given the following factor betas and factor risk premiums? Assume the risk-free rate is equal to 2%. Factor betas: - Standardized probability of default: 0.5 - Standardized average daily trading volume: -0.2 - Standardized average earnings growth forecast: 1.5 Expected factor risk premiums: - Standardized probability of default: 2% - Standardized average daily trading volume: -1% - Standardized average earnings growth forecast: 1.5%
A
3.5%
B
4.8%
C
5.5%
D
6.1%
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