1 3 = RRF + (rM-rRF) · ß b. If the expected value of r M is 10 percent and r RF is 6 percent, wha... more 1 3 = RRF + (rM-rRF) · ß b. If the expected value of r M is 10 percent and r RF is 6 percent, what is the required rate of return on Stock Y? Required rate return equation is as follows 0 2 1 3 = RRF + (rM-rRF) · ß 0 2 1 3 = 6 + (10-6) · 0.50 0 2 1 3 = 8% c. Suppose that in January 2014 investors learn that Firm Y will, in the future, face much greater competition, and investors conclude that Stock Y will, in the future, be exposed to much higher non diversifiable risk. Expected future profits and dividends, however, are unchanged (although the uncertainty about profits and dividends does increase). What effect is this knowledge likely to have on (1) Stock Y's market price, on (2) the realized rate of return on Stock Y during 2014, on (3) the required rate of return on the stock, and on (4) the expected rate of return on the stock in the future? The stock is now riskier. With greater risk and the same expected earnings and dividends, the price of the stock would fall. Thus, capital losses would be incurred, and they would offset if not overwhelm the dividend return, with the net result being a low or even negative realized rate of return during 2010. The required rate of return would rise. With the same expected dividends and dividend growth rate, but a lower market price, the expected rate of return on the now lower priced stock would rise to equal the now higher required rate of return. d. Suppose that during 2014 Stock Y had a return of minus 5 percent, while the market return was 20 percent. What would this do to the calculated beta coefficient for Stock Y? rY = 2.75 + 0.3rM. beta = 0.3. e. Calculate the required rate of return for Stock Y. Assume r M = 10 percent and r RF = 6 percent. Required rate return equation is as follows
1 3 = RRF + (rM-rRF) · ß b. If the expected value of r M is 10 percent and r RF is 6 percent, wha... more 1 3 = RRF + (rM-rRF) · ß b. If the expected value of r M is 10 percent and r RF is 6 percent, what is the required rate of return on Stock Y? Required rate return equation is as follows 0 2 1 3 = RRF + (rM-rRF) · ß 0 2 1 3 = 6 + (10-6) · 0.50 0 2 1 3 = 8% c. Suppose that in January 2014 investors learn that Firm Y will, in the future, face much greater competition, and investors conclude that Stock Y will, in the future, be exposed to much higher non diversifiable risk. Expected future profits and dividends, however, are unchanged (although the uncertainty about profits and dividends does increase). What effect is this knowledge likely to have on (1) Stock Y's market price, on (2) the realized rate of return on Stock Y during 2014, on (3) the required rate of return on the stock, and on (4) the expected rate of return on the stock in the future? The stock is now riskier. With greater risk and the same expected earnings and dividends, the price of the stock would fall. Thus, capital losses would be incurred, and they would offset if not overwhelm the dividend return, with the net result being a low or even negative realized rate of return during 2010. The required rate of return would rise. With the same expected dividends and dividend growth rate, but a lower market price, the expected rate of return on the now lower priced stock would rise to equal the now higher required rate of return. d. Suppose that during 2014 Stock Y had a return of minus 5 percent, while the market return was 20 percent. What would this do to the calculated beta coefficient for Stock Y? rY = 2.75 + 0.3rM. beta = 0.3. e. Calculate the required rate of return for Stock Y. Assume r M = 10 percent and r RF = 6 percent. Required rate return equation is as follows
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