You are considering buying another stock which is expected to pay an annual dividend of $2.00 over the next year. The price of the stock is $50 and it is expected to rise to $53 over the coming year. Your analysis using the SML has indicated that this stock has a required return of 8% - i.e. you should not buy it unless you can expect to earn at least an 8% return over the next year.
a. Compute the expected return, compare it to the 8% required return, and conclude whether or not you shou buy the stock.
b. Assuming the expected return you compute is different than the 8% required return, determine if the stock is over-valued or under valued.
c. Explain the process by which the market is likely to push the stock's expected return more in line with the stcok's required return of 8%