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CAPM, price of bonds, dividends

1) You are holding a stock which is currently in equilibrium. The required rate of return on the stock is 15 percent when the required return on the S&P 500 index is 10 percent. What will be the percentage change in the required return on the stock if the required return on the S&P 500 index increases by 30% while the risk free rate is unchanged? Your stock has a beta of 2.0.

a. +20%
b. +30%
c. +40%
d. +50%
e. +60%

2) A 20 year bond with a par value of $1000 has a 9 percent annual coupon. The bond currently sells for $925. If the bond's yield to maturity remains at its current rate, what will be the price of the bond 5 years from now?

a. $966.79
b. $831.35
c. $1090.00
d. $933.09
e. $925.00

3) Which of the following statements is most correct?

a. Assume that the required rate of return on a given stock is 13 percent. If the stock's dividend is growing at a constant rate of 5%, its expected dividend yield is also 5%.
b. The dividend yield on a stock is equal to the expected return less the expected capital gains yeild.
c. A stock's dividend yield cna never exceed the expected growth rate.
d. All of the answers above are correct.
e. Answers b and c are correct.

Solution Preview

You are holding a stock which is currently in equilibrium. The required rate of return on the stock is 15 percent when the required return on the S&P 500 index is 10 percent. What will be the percentage change in the required return on the stock if the required return on the S&P 500 index increases by 30% while the risk free rate is unchanged? Your stock has a beta of 2.0.

a. +20%
b. +30%
c. +40%
d. +50%
e. +60%

Answer: c. +40%

Let us first find the risk free rate

CAPM (Capital Asset Pricing Model equation is:
r A= r f + beta A (r m - r f)

risk free rate= r f = to be determined
beta of stock= beta A= 2.0 (Given)
return on market portfolio= r m = 10% (S&P 500 index)
required return on stock r A = 15.00% (Given)
Plugging in the values
r f = 5. %

Now the required return on market portfolio increass by 30%
Therefore r m= 13% =10% * (1+30%)
risk free rate remians the same
Now calculate the required return on the stock

r A= r f + beta A (r m - r f)

risk free rate= r f = 5. ...

Solution Summary

Answers to 3 corporate finance multiple choice questions dealing with CAPM, price of bonds, dividends

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