Q4 An analyst gathered the following information for a stock

Q4) An analyst gathered the following information for a stock and market parameters: stock beta = 0.85; expected return on the Market = 9.50%; expected return on T-bills = 1.80%; current stock Price = $9.01; expected stock price in one year = $11.04; expected dividend payment next year = $1.13. Calculate the       a) Required return for this stock (1 point):

b) Expected return for this stock  (1 point):

Q5) The market risk premium for next period is 5.00% and the risk-free rate is 1.50%. Stock Z has a beta of 1.40 and an expected return of 10.00%. What is the:     a) Market\'s reward-to-risk ratio? (1 point):

b) Stock Z\'s reward-to-risk ratio (1 point):

Solution

Q4 The required rate of return is the minimum rate of return which will be accepted for investment in the stock. The expected rate of return is the rate of return which is expected by the investor. Most of the times, both the terms are used interchangeably. Both are calculated by the same formula. Ra = rf +Ba (rm –rf) Ra= Required or expected return on stock rf= risk free rate Ba= beta rm= market rate of return If the risk free rate is not given, the T bills rate is considered as risk free rate as it bears no risk. Ra = 1.8% +.85(9.5%- 1.8%) Ra = = 8.345% Q5 Market risk premium is the minimum risk free rate which the investors should expect as a return on their investment. It is the expected return minus risk free rate. The reward to risk ratio of the market is 5% Stock Z reward to risk ratio= Expected return- risk free rate/Beta Stock Z reward to risk ratio=10%-1.5%/1.40 Stock Z reward to risk ratio=6.07%