- The common share of a co are expected to pay a dividend of $1.00 per share over the next year and to be traded at a price of $9.50 in one year time. What is the current market price of a common share of the co if the market price of risk is 7%, the risk-free rate of return is 2%, and the co beta is 1.40? a) $8.50 b) $9.39 c) $9.56 d) $9.63 2) Assume that in one year a co common shares will pay an expected dividend of $3.00 per share and trade for $13. If the investor’s risk assessment of the co is that the required rate of return is 10%, what are the co’s shares currently selling for? a) $10.00 b) $11.54 c) $12.35 d) $14.55 3) Assume that a co shares trade at the begining of the year for $61 and the expected dividend is $9. if you expect the shares to trade for $68 at the end of the year, what is the expected return for the co? a) 26% b) 28% c) 32% d) 35%
agree – B, D, A in that order all are applications of HPY = (P1 - P0 + D1)/ P0
nevermind. did that wrong
Can someone please explain HPY? thanks
Holding Period Yield = ( Price at End - Price at Beginning + Dividends Earned ) / Price at beginning So for Problem 1: P1 = 9.50, D1 = 1, P0 = ? HPY = given = 2 + 1.4 ( 7 ) = 11.8% so .118 = (9.5 + 1 - P0) / P0 so 1.118 Po = 10.5 P0 = 9.39 and so on for the others.
B -> $9.39177101 D- > $14.5454545 A -> 26.22950819% - Dinesh S
For Q1 : Should the return on the stock (HPY) not be : 2+1.4(7-2) = 9% So 1.09Po=10.5, Po= 9.63 I think Market Price of Risk should be equal to Rm and not Risk Premium? Is it not true.
Expected Return as per CAPM model = RFR + Beta*(Expected Market Return - RFR) where “Expected Market Return - RFR” is also the Market Risk over the Risk Free Rate. So we need to use the 7% directly in the calculations. - Dinesh S
b d a for Q1, market price of risk = risk premium. Risk prem = Rm-Rf.