Question 1 a. Consider a single factor APT. Stocks A and B have expected returns of 15% and 18% respectively. The risk-free rate is 6%. Stock B has a factor beta of 1. If arbitrage opportunities are ruled out and APT holds, what would be the factor beta of stock A? (5 marks) b. Discuss the application of APT in practice and whether it is more used than the CAPM model. (10 marks) c. Assume that stock returns in a particular market should be affected by the following factors: a stock’s beta with the bond index, its dividend yield and the firm size. Furthermore, assume a riskless rate of 5%. Find the expected return on stock ABC if the following annualised data is given: Factor Factor beta Risk premiums (in %) Bond Beta 1.2 5.36 Dividend Yield 6 0.24 Size 0.8 -5.50 (3 marks) d. If the observed return of stock in c) is 10% is that stock under or overvalued? (2 marks) e. What can you infer about factors in the APT model? (5 marks)