Suppose the CAPM holds and the stock of the firm APP Ltd. has a beta of 0.8. For simplicity, assume that the daily risk-free rate is 0%.

April 1

May 1

June 1

Market Return

-1%

2%

1%

Beginning Market Cap of APP

$100 Mil.

$120 Mil.

$125 Mil.

a)On April 1, APP announces a surprising $10 million lawsuit against its main rival, SAM Ltd. After the announcement, the market consensus is that APP has a 50% chance of winning. What is your best guess of APP's stock return on this date? Assume the lawsuit's result has no direct impact on their operations.

b)Now suppose the news about the lawsuit was leaked out on March 15. What is your best guess of APP's stock return on April 1?

c)On May 1, new information about the lawsuit increases the census estimate of winning by APP to 80%. What is your best guess of APP's stock return on this date?

d)On June 1, the verdict date, APP wins the lawsuit and is awarded $10 million. What is your best guess of APP's stock return on this date?

Answer rating: 100% (QA)

a Given the announcement of the lawsuit the market will likely react negatively as it introduces unc... View the full answer