2. Stocks A and B have the following data. The market risk premium is 6.0% and t

Question

2. Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

A B
Beta 1.10 0.90
Constant growth rate 7.00% 7.00%

a. Stock A must have a higher stock price than Stock B.
b. Stock A must have a higher dividend yield than Stock B.
c. Stock B’s dividend yield equals its expected dividend growth rate.
d. Stock B must have the higher required return.
e. Stock B could have the higher expected return.

Explanation / Answer

Portfolio Beta = w1*B1 + w2*B2 where w1 & w2 are stock %. Here they are each 50% so Portfolio Beta = 0.5*1.10 + 0.5*0.90 = 1.00 RPM = kM - kRF where Km is Reqd Rate of Return So Km = RPM +kRF = 6%+6.4% = 12.4% Required return on Stock i =Risk-free rate + Market riskpremium*Stock i's beta SO Ki = kRF +RPM*Bi SO for Stock 1, K1 = 6.4%+6%*1.10 = 13% &for STock 2, K2 = 6.4%+6%*0.90 = 11.80% As Stock 1 rate of Return K1 = 13% which is more than Reqd rate of return of 12.4%, Ans is (a) Stock A must have a higher stock price than Stock B

Related Questions

Navigate

• Browse (All)
• Browse 2
• Subjects

---

---

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