Answer: 4.94%

## Explanation To calculate the expected annual return for stock BBZ using the three-factor model, we follow these steps: ### Step 1: Calculate Factor Excess Returns We subtract the risk-free rate from each factor's expected return: - **Factor P excess return**: 5.40% - 2.10% = 3.30% - **Factor Q excess return**: 6.80% - 2.10% = 4.70% - **Factor R excess return**: 3.00% - 2.10% = 0.90% ### Step 2: Calculate Expected Return from Factor Exposures We multiply each factor's excess return by stock BBZ's corresponding factor beta: - Factor P contribution: 0.95 × 3.30% = 3.135% - Factor Q contribution: (-0.40) × 4.70% = -1.880% - Factor R contribution: 1.20 × 0.90% = 1.080% **Total factor contribution**: 3.135% + (-1.880%) + 1.080% = 2.335% ### Step 3: Calculate Total Expected Return We add the alpha and risk-free rate to the factor contribution: - Factor contribution: 2.335% - Alpha: 0.50% - Risk-free rate: 2.10% **Total expected return**: 2.335% + 0.50% + 2.10% = 4.935% ≈ **4.94%** ### Why Other Options Are Incorrect: - **A (2.84%)**: Forgets to add back the risk-free rate - **C (6.01%)**: Uses total returns instead of excess returns and forgets to add alpha - **D (6.51%)**: Uses total returns instead of excess returns The key insight is that we must use **excess returns** (above risk-free rate) for the factor calculations, then add back the risk-free rate and alpha at the end.

Author: LeetQuiz .