b. 6. Consider the Fama-French (1993) three-factor model: Fa- rA = aj + Bim (Rmt – rt) + BiSMB, + BiHML, + it %3D where Rmes SMB;, and HML, are the market, book-market, and size factors, respectively. To analyze one stock, you run the above regression on the three factors and obtain a;= 1%, Bm= 0.9, Bi,= 0.3, and 3;,= 0.2. Assume that the market beta is the same if you get it from either the CAPM or the three-factor regression. (In practice, the values are close.) Suppose that the risk-free interest rate is 3%, and that the market, book- market, and size premiums are 12%, 5%, and 6%, respectively. a. What is the required rate of return on the stock if you believe the CAPM to be an accurate descriptor? b. What would your answer be if believed the three-factor model were a more nearly accurate descriptor? C. What would your answer be if you do not believe factor models are valid? you your you
b. 6. Consider the Fama-French (1993) three-factor model: Fa- rA = aj + Bim (Rmt – rt) + BiSMB, + BiHML, + it %3D where Rmes SMB;, and HML, are the market, book-market, and size factors, respectively. To analyze one stock, you run the above regression on the three factors and obtain a;= 1%, Bm= 0.9, Bi,= 0.3, and 3;,= 0.2. Assume that the market beta is the same if you get it from either the CAPM or the three-factor regression. (In practice, the values are close.) Suppose that the risk-free interest rate is 3%, and that the market, book- market, and size premiums are 12%, 5%, and 6%, respectively. a. What is the required rate of return on the stock if you believe the CAPM to be an accurate descriptor? b. What would your answer be if believed the three-factor model were a more nearly accurate descriptor? C. What would your answer be if you do not believe factor models are valid? you your you
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question number 6
Transcribed Image Text:b.
6. Consider the Fama-French (1993) three-factor model:
Fa- rA = aj + Bim (Rmt – rt) + BiSMB, + BiHML, + it
%3D
where Rmes SMB;, and HML, are the market, book-market, and size factors,
respectively. To analyze one stock, you run the above regression on the three
factors and obtain a;= 1%, Bm= 0.9, Bi,= 0.3, and 3;,= 0.2.
Assume that the market beta is the same if you get it from either the CAPM
or the three-factor regression. (In practice, the values are close.)
Suppose that the risk-free interest rate is 3%, and that the market, book-
market, and size premiums are 12%, 5%, and 6%, respectively.
a. What is the required rate of return on the stock if you believe the CAPM to
be an accurate descriptor?
b. What would your answer be if believed the three-factor model were a
more nearly accurate descriptor?
C. What would your answer be if you do not believe factor models are valid?
you
your
you
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