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Answer: 6.4%
## Explanation This is a multi-factor model question where we need to calculate the expected return based on macroeconomic factor shocks. **Given:** - Baseline expected return: 5.0% - Factor betas: - βIndustrial production = 1.30 - βInterest rate = -0.75 - Baseline scenario: - Industrial production growth = 3.0% - Interest rate = 1.5% - Forecast scenario: - Industrial production growth = 4.2% - Interest rate = 1.75% **Step 1: Calculate the shocks (deviations from baseline)** - Industrial production shock = 4.2% - 3.0% = 1.2% - Interest rate shock = 1.75% - 1.5% = 0.25% **Step 2: Calculate the impact of each shock** - Industrial production impact = βIndustrial production × Industrial production shock = 1.30 × 1.2% = 1.56% - Interest rate impact = βInterest rate × Interest rate shock = -0.75 × 0.25% = -0.1875% **Step 3: Calculate total expected return** Total expected return = Baseline return + Industrial production impact + Interest rate impact = 5.0% + 1.56% + (-0.1875%) = 5.0% + 1.56% - 0.1875% = 6.3725% ≈ 6.37% **Step 4: Compare with options** 6.37% is closest to option B (6.4%) **Key Concept:** In multi-factor models, the expected return equals the baseline return plus the sum of (factor beta × factor shock) for each factor.
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An analyst is estimating the sensitivity of the return of stock A to different macroeconomic factors. The following estimates for the factor betas are prepared:
βIndustrial production = 1.30, βInterest rate = -0.75
Under baseline expectations, with industrial production growth of 3.0% and an interest rate of 1.5%, the expected return for Stock A is estimated to be 5.0%. The economic research department is forecasting an acceleration of economic activity for the following year, with industrial production forecast to grow to 4.2% and interest rates increasing 25 bps to 1.75%. According to this forecast, what return of Stock A can be expected for next year?
A
4.8%
B
6.4%
C
6.8%
D
7.8%
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