Question 5 Risk and return (23 marks)

a) STC Inc. is expecting their ice cream sales to decline due to the increased interest in healthy eating and COVID-19. Thus, the company has announced that they will be reducing their annual dividend by 5% a year for the next five years. After that, they will maintain a constant dividend of $1.2 a share for a long time. Last year, the company paid $2.30 dividend per share. What is this stock worth to you if you require a 13% rate of return? (4 marks) b) Explain the equity premium puzzle using historical statistics of the Canadian bond and stock markets. Explain the equity premium puzzle and how it was evident in Canada until the end of the last century and what happened after that until 2008. (4 marks)

c) Write a short paragraph showing how the Separation Theorem in Markowitz Portfolio Theory changed the investment industry after it was published. (5 marks)

d) Sophisticated investors use the Sharpe CAPM to price stocks by constructing an efficient tangency portfolio. The following table gives some characteristics of two risky assets - stocks and bonds. Also shown are weights in the tangency portfolio P, which is constructed to be mean-variance efficient, i.e., it provides the highest expected return for its level of variance.

Asset	Weigh in Market Portfolio P	Expected Return	Standard Deviation	Covariance With Stocks	Covariance With Bonds
Stocks	0.40	?	0.20	1.00	0.05
Bonds	0.60	?	0.10	0.05	1.00

If the expected return on the tangency portfolio P, E(r_P) is equal to 0.09 or 9 percent, what are the expected returns on stocks and bonds? Assume the risk-free rate, r_f is equal to 0.04 or 4 percent and show all working steps clearly. Also justify the use of the formulas at the beginning. (10 marks)