FIN 300 Ch. 7 and 8

Suppose you are considering buying a stock. The stock is currently trading for $298. You expect the price in one year to be $301and it will pay a dividend of $4. You estimate the stock's beta at 1.2, the risk-free rate at 3%, and the expected return on the market at 9%. According to the CAPM, what is the maximum price you should be willing to pay for this stock?

$276.77

Suppose you are considering buying a stock. The stock pays a dividend of $3 per year with the next dividend due one year from today. Using the CAPM, you estimate your required return at 10% to compensate you for the risk of this stock's cash flows. What is the maximum price you are willing to pay for a share of the stock?

$30

Suppose you are considering buying a stock. You expect the stock to pay a dividend of $2one year from today and that the dividend will grow 3% each year after that. Using the CAPM, you estimate your required return at 8% to compensate you for the risk of this stock's cash flows. What is the maximum price you are willing to pay for a share of the stock?

$40

Suppose you are considering buying a stock. You expect the stock to pay a dividend of $3one year from today, $3.50 two years from today, and then dividend will grow 2% each year after that. Using the CAPM, you estimate your required return at 9% to compensate you for the risk of this stock's cash flows. What is the maximum price you are willing to pay for a share of the stock?

$45.36

Suppose you have a portfolio equally invested in four stocks. Each stock's expected return, standard deviations, and beta are in the following table. What is your portfolio's beta?

0.625

You use the CAPM to estimate Stock J's required return at 7%. If the risk-free rate is 2% and the expected return on the market portfolio is 5%. What is your estimate for Stock J's beta?

1.67

Suppose you are considering buying a stock. The stock is currently trading for $105. You expect the price in one year to be $110and it will pay a dividend of $2. What is the dividend yield?

1.90%

Suppose you are considering buying a stock. The stock is currently trading for $45. You expect the price in one year to be $48and it will pay a dividend of $3. What is your expected rate of return if you were to buy the stock today, hold it for one year, receive the $3dividend, and then immediately sell it for $48?

13.33%

Suppose you have a portfolio equally invested in four stocks. Each stock's expected return, standard deviations, and beta are in the following table. What is your portfolio's expected return?

4.0%

Suppose Stock A has the following returns over the last five years: 8%, 5%, 9%, 2%, and −2%. What is the realized annual return?

4.32%

Suppose Stock A has the following returns over the last five years: 8%, 5%, 9%, 2%, and −2%. What is the average annual return?

4.4%

Suppose you are considering buying a stock. The stock is currently trading for $105. You expect the price in one year to be $110 and it will pay a dividend of $2. What is the capital gains?

4.76%

Suppose you are considering buying a stock with a beta of 0.7. What is your required return given by the CAPM if the expected return on the market is 8%, the risk-free rate is 1%?

5.9%

Which of the following statements about preferred stock is FALSE?

A share of common stock offers the owner a right to vote on the corporation's major decisions.

Which of the following is true about beta?

Beta measures an asset's exposure to market risk.

You are considering purchasing a stock. Using the DDM and CAPM, you calculate the stock's expected return at 15%. The CAPM gives a required return of 12%. What should you do and why should you do it?

Buy the stock because it offers a high enough return to justify its risk.

You are considering purchasing a stock. Using the DDM and CAPM, you calculate the stock's intrinsic value at $101. The stock is currently trading at $105. What should you do and why should you do it?

Do not buy the stock because it does not offer a high enough return to justify its risk.

Suppose you have a portfolio made up of 40% Stock A, 35% Stock B, and 25% Stock C. Stock A has an expected return of 15% and a beta of 1.8, Stock B has an expected return of 9% and a beta of 1.3, and Stock C has an expected return of 6% and a beta of 0.8. What is the expected return and beta of your portfolio?

E[rp] = 10.65%, βp= 1.13

TRUE or FALSE: A large enough portfolio will eliminate all risk.

False

TRUE or FALSE: The intrinsic value of a dividend-paying stock cannot be determined because the share does not mature and pays dividends forever. The intrinsic value is effectively infinite.

False

TRUE or FALSE:The risk of a portfolio increases as you add more stocks with correlation coefficients less than one to the portfolio.

False

TRUE or FALSE?Most corporations offer shares of preferred stock.

False

Which of the following is true about a stock's price?

Holding all else constant, a stock's price should increase when a corporation's expected future earnings increase.

Stock X and Stock Y each have a standard deviation of 40%. If the stocks have a correlation coefficient less than one, then a portfolio of the two stocks has a standard deviation of _________________.

Less than 40%.

Which of the following is true about diversifiable risk?

Some diversifiable risk can be eliminated by holding a well-diversified portfolio.

Suppose you have a portfolio equally invested in four stocks. Each stock's expected return, standard deviations, and beta are in the following table. Which stock is contributing the most risk to your portfolio? Which stock is reducing your portfolio's risk the most?

Stock A is contributing the most risk. Stock Dis reducing the portfolio's risk the most.

Which of the following is true about the correlation coefficient?

The correlation coefficient measures the degree to which assets' returns tend to move together.

How is the intrinsic value of a share of common stock determined according to the Dividend Discount Model (DDM)?

The intrinsic value is the present value of the expected future cash flows discounted at an appropriate rate given the cash flows' risk.

Suppose you are considering buying a stock. The stock is currently trading for $75. You expect the price in one year to be $76and it will pay a dividend of $2. You estimate the stock's beta at 0.9, the risk-free rate at 2%, and the expected return on the market at 7%. According to the CAPM, should you consider purchasing this stock?

The intrinsic value is$73.24. The current price is $75. You should consider buying the stock.

The required return of a stock given by the CAPM is _______________.

The minimum return the average investor requires as compensation for the risk of holding the stock.

Suppose you are considering buying a stock. The stock is currently trading for $30. You expect the price in one year to be $34and it will pay a dividend of $1. You estimate the stock's beta at 1.5, the risk-free rate at 1%, and the expected return on the market at 8%. According to the CAPM, should you consider purchasing this stock?

The required return is 11.5% and the expected return is 16.67%. You should consider buying the stock.

Holding all else constant, what would you expect to happen to the price of a share of stock if the expected return on the market increased? Use the CAPM and DDM to answer this question.

The stock's price would decrease because the discount rate increased.

You are deciding whether to buy Stock A. You estimate Stock A's beta at 0.3 and its expected return at 4% over the next year. The risk-free rate is 1.5% and you estimate the market portfolio's expected return at 6%. You are using the CAPM to decide if the stock's expected return is high enough to compensate you for the risk of holding the stock. Based on the CAPM, should you buy the stock?

The stock's required return is 2.85%. Yes, you should buy it.

Which of the following is TRUE about a dividend paying stock's total expected return?

The total expected return comes from two sources: the dividend yield and capital gains.

Suppose you are considering buying a stock. The stock is currently trading for $20. You expect the price in one year to be $22and it will pay a dividend of $0.50. What is the stock's total expected return? What portion of the total return is from the dividend yield and what portion is from capital gains?

Total return = 12.5%, dividend yield = 2.5%, and capital gains = 10%.

TRUE or FALSE: Stocks have both diversifiable risk and market risk, but the market will only systematically offer higher expected returns for bearing market risk.

True

TRUE or FALSE: When holding stocks in a portfolio, the amount of risk that is eliminated depends on the degree to which the stocks' returns are correlated.

True

A stock with a beta of 2 tends to have returns that are_________________.

About twice as volatile than the market's returns.

Which of the following is true about market risk?

All of these.

Which of the following is true about the CAPM theory and is important to keep in mind when using the model to estimate your minimum required rate of return for an asset?

All of these.

Which of the following statements about common stock is TRUE?

All of these.