Question:
What would you expect the effect to be of the following changes on the market price of a company's shares, all other things being the same? Provide an explanation of your expectation.
a. Investors demand a higher required rate of return on shares in general
b. The covariance between the company's rate of return and that for the market decreases
c. The standard deviation of the probability distribution of rates of return for the company's stock increases
d. Market expectations of the growth of future earnings (and dividends) of the company are revised downwards.
My answer are as follows, however I am having difficulties explaining the reason in details. Could you please assist?
a) When investors demand a higher required rate of return on shares, we can expect the market price to decline due to the following reasons:
- Internal pressure within the company to generate greater revenue
- Greater outward cash flows to shareholder in the form of dividend
b) When the covariance between the company’s rate of return and that of the market decreases, we can expect the Beta of security to also decrease, hence giving rise to an increase in the value of the company’s shares.
c) When the standard deviation of the probability distribution of rates of return for the company’s stock increases , we can expect the risk to be high therefore market price of share will decrease in value.
d) When the Market expectations of the growth of future earnings (and dividends) of the company are revised downwards, we can expect the price of the shares to fall.