Explanation:
The change in the expected return is equal to the sum of the products of factor betas and the changes in the respective factor values.
Change in industrial production = 8% - 5% = 3% Change in interest rates = 7% - 4% = 3% Change in inflation = 5% - 3% = 2%
Change in expected return = $1.5 \times 3% + (-0.5) \times 3% + (-0.75) \times 2% = 4.5% - 1.5% - 1.5% = 1.5%$.
New expected return = baseline expected return + change = $8% + 1.5% = 9.5%$.
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Q.89 An analyst wishes to estimate how the return of a certain stock reacts to changes to three key microeconomic factors: industrial production, interest rates, and inflation. The factor betas have been estimated as follows:
| Factor | Beta (β) |
|---|---|
| Industrial production | 1.5 |
| Interest rates | −0.5 |
| Inflation | −0.75 |
Under the analyst’s baseline scenario, an industrial production growth of 5% combined with an interest rate level of 4% and inflation rate of 3% would bring about an expected return of 8% for the stock. Data from a reliable policy think tank predicts that next year, there will be accelerated economic activity where industrial production will grow by 8%, interest rates by 7%, and inflation by 5%. According to this forecast, what’s the expected return on the stock for next year?
A
8.0%.
B
10.0%.
C
9.5%.
D
6.5%.
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