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Explanation:
The expected return for the stock will be the sum of the expected return under the baseline scenario, and the impact of “shocks” (excess returns) attributed to each of the three factors.
First, we work out these shocks:
| Factor | Baseline Scenario (A) | Prediction (B) | Shock (A − B) |
|---|---|---|---|
| Industrial Production | 5% | 8% | 3% |
| Interest rate | 4% | 7% | 3% |
| Inflation | 3% | 5% | 2% |
Therefore, the expected return for the new scenario will be given by:
Expected stock return + β<sub>Industrial production</sub> × Industrial production shock
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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%.