Question #7

Assume you are considering forming a common stock portfolio consisting of 25% Stonebrook Corporation (Stone) and 75% Rockway Corporation (Rock). As expressed in the two-factor returns models presented below, both of these stocks' returns are affected by two common factors: surprises in interest rates and surprises in the unemployment rate. RStone = 0.11 + 1.0FInt + 1.2FUn + εStone RRock = 0.13 + 0.8FInt + 3.5FUn + εRock Assume that at the beginning of the year, interest rates were expected to be 5.1% and unemployment was expected to be 6.8%. Further, assume that at the end of the year, interest rates were actually 5.3%, the actual unemployment rate was 7.2%, and there were no company-specific surprises in returns. This information is summarized in Table 1 below: Table 1: Expected versus Actual Interest Rates and Unemployment Rates Actual Expected Company-specific returns surprises Interest Rate 0.053 0.051 0.0 Unemployment Rate 0.072 0.068 0.0 What is the expected return for Stonebrook in the absence of surprises?