The beta coefficient for Stock C is bC = 0.4 and that for Stock D is bD = −0.5. (Stock D’s beta is negative, indicating that its rate of return rises whenever returns on most other stocks fall. There are very few negative-beta stocks, although collection agency and gold mining stocks are sometimes cited as examples.)
a. If the risk-free rate is 9% and the expected rate of return on an average stock is 13%, what are the required rates of return on Stocks C and D?
b. For Stock C, suppose the current price, P0, is $25; the next expected dividend, D1, is $1.50; and the stock’s expected constant growth rate is 4%. Is the stock in equilibrium? Explain, and describe what would happen if the stock were not in equilibrium.