Consider the following information about two stocks (D and E) and two common risk factors (1 and
Question:
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a. Assuming that the risk-free rate is 5.0%, calculate the levels of the factor risk premia that are consistent with the reported values for the factor betas and the expected returns for the two stocks.
b. You expect that in one year the prices for Stocks D and E will be $55 and $36, respectively. Also, neither stock is expected to pay a dividend over the next year. What should the price of each stock be today to be consistent with the expected return levels listed at the beginning of the problem?
c. Suppose now that the risk premium for Factor 1 that you calculated in Part a suddenly increases by 0.25% (i.e., from x% to (x + 0.25) %, where x is the value established in Part a. What are the new expected returns for Stocks D and E?
d. If the increase in the Factor 1 risk premium in Part c does not cause you to change your opinion about what the stock prices will be in one year, what adjustment will be necessary in the current (i.e., today's)prices?
Stocks or shares are generally equity instruments that provide the largest source of raising funds in any public or private listed company's. The instruments are issued on a stock exchange from where a large number of general public who are willing... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their... Expected Return
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...
Step by Step Answer:
a ER D 50 12 l 1 34 l 2 131 ER E 50 2 6l 1 2 6l 2 154 Solving the second equation for ...View the full answer
Investment Analysis and Portfolio Management
ISBN: 978-0538482387
10th Edition
Authors: Frank K. Reilly, Keith C. Brown
