The beta coefficient for Stock C is b C = 0.4, and that for Stock D is b D = - 0

Question

The beta coefficient for Stock C is bC = 0.4, and that for Stock D is bD = - 0.3. (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.)

I. In this situation, the expected rate of return = 9.20%. However, the required rate of return is 10%. Investors will seek to buy the stock, raising its price to $28.85. At this price, the stock will be in equilibrium.
II. In this situation, the expected rate of return = 10%. However, the required rate of return is 9.20%. Investors will seek to sell the stock, raising its price to $28.85. At this price, the stock will be in equilibrium.
III. In this situation, the expected rate of return = 9.20%. However, the required rate of return is 10%. Investors will seek to sell the stock, raising its price to $28.85. At this price, the stock will be in equilibrium.
IV. In this situation, the expected rate of return = 10%. However, the required rate of return is 9.20%. Investors will seek to buy the stock, raising its price to $28.85. At this price, the stock will be in equilibrium.
V. In this situation, both the expected rate of return and the required rate of return are equal. Therefore, the stock is in equilibrium at its current price.

Explanation / Answer

E(rC) = 6% + 0.4(14 - 6)
= 6% + 3.2%
= 9.2%

E(rD) = 6% + -0.3(14 -6)
= 6% - 2.4%
= 3.6%

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.