Consider a three-factor APT model. The

factors and associated risk premiums are:

Factor Risk

Premium

Change in GNP 5%

Change in energy prices -1

Change

in long-term interest rates +2

Calculate expected rates of return

on the following stocks. The risk-free interest rate is 7%.

a. A stock whose return is

uncorrelated with all three factors.

b. A

stock with average exposure to each factor (i.e., with b = 1 for each).

c. A

pure-play energy stock with high exposure to the energy factor (b = 2) but zero

expo- sure to the other two factors.

d. An aluminum company stock with

average sensitivity to changes in interest rates and GNP, but negative exposure

of b = -1.5 to the energy factor. (The aluminum company is energy-intensive and

suffers when energy prices rise.)