The equity premium and the value of stocks

a. Explain why, in equation (14.14), it is important that the stock is ex-dividend, that is, it has just paid its dividend and expects to pay its next dividend in one year.

b. Using equation (14.14), explain the contribution of each component to today's stock price.

c. If the risk premium is larger, all else equal, what happens to the price of the stock today?

d. If the one-period interest rate increases, what happens to the price of the stock today?

e. If the expected value of the stock at the beginning of period \(t+1\) increases, what happens to the value of the stock today?

f. Now look carefully at equation (14.15). Set \(i_{1 t}=i_{1 t+n}\) \(=0.05\) for all \(n\). Set \(x=0.03\). Compute the coefficients on \(\$ D_{t+3}^{e}\) and \(\$ D_{t+10}^{e}\). Compare the effect of a \(\$ 1\) expected increase in a dividend 3 years from now and 10 years from now.
g. Repeat the computation in

(f) with \(i_{1 t}=i_{1 t+n}=0.08\) for all \(n\) and \(x=0.05\)

Equation 14. 14

Equation 14. 15

Transcribed Image Text:

$0. = $Di+1 (1 + i + x) $0i+1 (1 + i + x) (14.14)