Question 46

A risk manager at Allied Investments is computing the expected return for Stock ABC with the arbitrage pricing theory (APT) model. He quickly realizes that a major weakness of the APT is that it offers no guidance as to the identification of the appropriate risk factors to use when applying the model. As a result, the manager attempts to apply the Fama-French three-factor model. Given the following data for Stock ABC, what is the abnormal performance of Stock ABC after controlling for its exposures to the market, firm size, and book-to-market factors?

• Expected return of Stock ABC = 6%.
• Risk-free rate = 2%.
• Market beta = 0.50.
• Market risk premium = 6%.
• Firm size (small minus big [SMB]) beta = 0.25.
• Firm size risk premium = 4%.
• Book-to-market (high minus low [HML]) beta = 0.3.
• Book-to-market risk premium = 4%.