Question

Suppose two factors are identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 4% and IR 6%. A stock with a beta of 1 on IP and 0.4 on IR currently is expected to provide a rate of return of 14%. If industrial production actually grows by 5%, while the inflation rate turns out to be 7%, what is your best guess for the rate of return on the stock? (Round your answer to 1 decimal place.)

Answer 1

Answer:

15.4%

Explanation:

Calculation to determine your best guess for the rate of return on the stock

The revised estimate on the rate of return on

the stock would be:

Before

14% = α +[4%*1] + [6%*0.4]

α = 14% - 6.4%

α = 7.6%

With the changes:

7.6% + [5%*1] + [7%*0.4]

= 7.6% + 5% + 2.8%

= 15.4%

Therefore your best guess for the rate of return on the stock will be 15.4%