Suppose the risk free rate is 4%. Suppose also that the expected return required by the market for a portfolio with a beta of 1.0 is 9%. Suppose you consider buying a share of stock at a price of $42. The stock is expected to pay a dividend of $3 next year and to sell then for $41. The stock risk has been evaluates at beta of 1.2.

(a) Is the stock overpriced or underpriced according to the capital asset pricing model?

(b) What might be the (current) fair price of the stock?

Solution Preview

The Capital Asset Pricing Model states that the rate of return of a stock=the risk-free rate+(beta*(the market rate of return-the risk-free rate). The excess of the market rate of return over the risk-free rate is called the market premium. Therefore, the rate of ...

Solution Summary

Given the components of the capital asset pricing model and a stock's current and expected price, as well as its expected dividend, this solution illustrates how to value the stock using the capital asset pricing model, how to determine its total return, and how to determine if it is fairly priced by comparing the two computations.

1. You own a stock portfolio invested 25% in stock Q, 20% in stock R, 15% in stock S, and 40% in stock T. The betas for these stocks are .84, 1.17, 1.11, and 1.36 respectively. What is the portfolio beta?
2. (UsingCAPM) A stock has a beta of 1.05, the expected return on the market is 11 % and the risk-free rate is 5.2 %.

1. Abigail Grace has a $900,000 fully diversified portfolio. She subsequently inherits ABC Company common stock worth $100,000. Her financial advisor provided her with the following estimates:
Expected Monthly Returns Standard Deviation of Monthly Returns
Original Portfolio 0.67% 2.37%
ABC Company 1

19.Determine what the Beta is for a firm that has the following characteristics: (a) Expected Return on the Company's Stock is 13%, (b) Risk Free Rate of Return is 3%, and (c) The Market's Return is expected to be 10%.
20. Using the 'constant growth model', determine what the investor's required rate of return is given the fo

Suppose the rate of return on short-term government securities (perceived to be risk-free) is 5%. Suppose also that the expected rate of return required by the market for a portfolio with a beta of 1 is 12%. According to the CAPM
1. What is the expected rate of return on the market portfolio?
2. Suppose you consider buyi

1. Find a low-risk stock -
Walmart or Kellogg would be a good candidate but any are welcome. Use monthly returns for the most recent three years to confirm that the beta is less than 1.0. Now estimate the annual standard deviation for the stock and the S&P index, and the correlation between the returns on the stock and the i

Frazier Manufacturing paid a dividend last year of $2, which is expected to grow at a constant rate of 5%. Frazier has a beta of 1.3. If the market is returning 11% and the risk-free rate is 4%, calculate the
value of Frazier's stock.

The following need worked out. Please show calculations.
1. Stock Valuation: A stock has an initial price of $100 per share, paid a dividend of $2.00 per share during the year, and had an ending share price of $125. Compute the percentage total return, capital gains yield, and dividend yield.
2. Total Return: You bought a

(Beta and required return) The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here.
a. Calculate the expected returns on the stock market and on Chicago Gear stock.
b. What is Chicago Gear's beta?
c. What is Chicago Gear's required return according to the CAPM?

1) Assume that the CAPM is a good description of stock price returns. The market expected return is 7% with 10% volatility and the risk-free rate is 3%. New news arrives that does not change any of these numbers but it does change the expected return of the following stocks:
Expected R