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Market price of security
Security expected rate of return
Risk free rate of return
Market risk premium
Change in beta (x)
Solution
Current security beta #DIV/0!
The market price of a security is $40. Its expected rate of
return is 13%. The risk-free rate is 7%, and the market risk
premium is 8%. What will the market price of the security be if
its beta doubles (and all other variables remain unchanged)?
Assume the stock is expected to pay a constant dividend in
perpetuity.
T-bill rate
Mareket return
Current share price
Year end dividend
Beta
Solution
Assume the risk-free rate is 8% and the expected rate of
return on the market is 18%. A share of stock is now selling
for $100. It will pay a dividend of $9 per share at the end of
the year. Its beta is 1. What do investors expect the stock to
sell for at the end of the year?
Investment Return Beta
ST govt
Market
Start stock price
End stock price
Dividend
Stock beta
Solution
Suppose the yield on short-term government securities (perceived to
be risk-free) is about 4%. Suppose also that the expected return
required by the market for a portfolio with a beta of 1 is 12%.
According to the capital asset pricing model:
a. What is the expected return on the market portfolio?
b. What would be the expected return on a zero-beta stock?
c. Suppose you consider buying a share of stock at a price of $40. The
stock is expected to pay a dividend of $3 next year and to sell then for
$41. The stock risk has been evaluated at beta = -0.5. Is the stock
overpriced or underpriced?
