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Consider the multi-factor APT model with two-factors. The risk premium on factor 1 and 2 portfolios are 8% and 3% respectively. Stock A has a beta of 1.3 on factor 1 and a beta of 0.7 on factor 2. The expected return on Stock A is 14%. If no arbitrage opportunities exist, the risk free rate is:

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chamberlainuket

Answer:

12.5%

Explanation:

Expected return = Risk free rate + (Beta of factor 1 * Risk premium of factor 1) + (Beta of factor 2 * Risk premium of factor 2)

14 = Risk free rate + (1.3*8) + (0.7*3)

Risk free rate = 12.5%

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