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The Arbitrage Pricing Model (APM). Suppose a three-factor APM holds and the risk-free rate is 6 percent. You are interested in two particular stocks. A and B. The returns on both stocks are related to factors 1 and 2 as follows.
r = 0.06 + b1 (0.09) - b2 (0.03) + b3 (0.04)
The sensitivity coefficients for the two stocks are given below.
Stock
b1
b2
A
0.70
0.80
0.20
B
0.50
0.04
Calculate the expected returns on both stocks. Which stock requires a higher return?
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