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Rates of Return and Equilibrium

The beta coefficient for stock C is bc=0.4 and that for stock D is bd=-.05. (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 stokcs
are sometimes cited as examples)

If the risk free rate is 9% and the expected rate of return on an average stock is 13%, what are the requried rates of return on stocks c and d?

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.

Solution Preview

If the risk free rate is 9% and the expected rate of return on an average stock is 13%, what are the requried rates of return on stocks c and d?

Using the CAPM equation,
Required return = Rf + (Rm-Rf) beta where
Rf = risk free rate = 9%
Rm = Market return = return on average stock = 13%
Stock C - The beta is 0.4
Required return for Stock C = 9% ...

Solution Summary

The solution explains how to calculate the required rate of return and whether a stock is in equilibrium

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