# Macro factor

why the expected return is just the intercept? why not take other factor into consideration?

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?

A) 11.0%. B) 13.0%. C) 13.2%.

The expected return for Stonebrook is simply the intercept return (ai) of 0.11, or = 11.0%. (Study Session 18, LOS 66.j, k)

You take the other factors into consideration but their expected values are zeros. By definition of surprise factor, E(FInt)=E(FUn)=E(eStone)=E(eRock)=0 E(RStone)=0.11+0