Question 1. Rates of return and equilibrium - Stock C's beta coefficient is bc = 0.4, while Stock D's is bd = -0.5. (Stock D's beta is negative, indicating that its return rises when returns on most other stocks fall. There are very few negative beta stocks, although collection agency stocks are sometimes cited as an example.)
a. If the risk-free rate is 7 percent and the expected rate of return on an average stock is 11 percent, what are the required rates on Stocks C and D?
b. For Stock C, suppose the current price, Po, is $25; the next expected dividend , D1, is $1.50; and the stock's expected constant growth rate is 4 percent. Is the stock in equilibrium? Explain, and describe what would happen if the stock is not in equilibrium.
Question 2. Two investors are evaluating GE's stock for possible purchase. They agree on the expected value of D1 and also on the expected future dividend growth rate. Further, they agree on the riskiness of the stock. However, one investor normally holds stocks for 2 years, while the other holds stocks for 10 years. On the basis of the type of analysis done in this chapter, should they both be willing to pay the same price for GE's stock?