Consider the following information about two stocks (D and E) and two common risk factors (factor 1 and factor 2) Stock Risk factor 1 Risk factor 2 Expected return (%) D 1.2 3.4 13.1 2.6 2.6 15.4 a. Assuming that the risk free rate is 5%, determine the risk premium for factors 1 and 2 that are consistent with the expected returns for the two stocks. You expect that in one year the prices of Stock D and E will be $55 and $36 respectively and pay no dividends. What should be the price of each stock today to be consistent with the expected return levels. b. C. Determine how to you identified if Stock D and E are overvalued, fairly valued and undervalued? d. Suppose the risk premium for factor 1 as computed in (a) increases by 0.25 percent, what will be the new expected return for D and E? e. Suppose the risk premium for factor 1 as computed in (a) decreases by 0.25%, what will be the new expected return for D and E? f. Devise how would you develop a Jensen Index using Arbitrage Pricing Theory. Illustrate with appropriate example.
Consider the following information about two stocks (D and E) and two common risk factors (factor 1 and factor 2) Stock Risk factor 1 Risk factor 2 Expected return (%) D 1.2 3.4 13.1 2.6 2.6 15.4 a. Assuming that the risk free rate is 5%, determine the risk premium for factors 1 and 2 that are consistent with the expected returns for the two stocks. You expect that in one year the prices of Stock D and E will be $55 and $36 respectively and pay no dividends. What should be the price of each stock today to be consistent with the expected return levels. b. C. Determine how to you identified if Stock D and E are overvalued, fairly valued and undervalued? d. Suppose the risk premium for factor 1 as computed in (a) increases by 0.25 percent, what will be the new expected return for D and E? e. Suppose the risk premium for factor 1 as computed in (a) decreases by 0.25%, what will be the new expected return for D and E? f. Devise how would you develop a Jensen Index using Arbitrage Pricing Theory. Illustrate with appropriate example.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Consider the following information about two stocks (D and E) and two common risk factors (factor 1 and factor 2)
Stock
Risk factor 1
Risk factor 2
Expected return (%)
D
1.2
3.4
13.1
2.6
2.6
15.4
a. Assuming that the risk free rate is 5%, determine the risk premium for factors 1 and 2 that are consistent with the expected returns for the two stocks.
You expect that in one year the prices of Stock D and E will be $55 and $36 respectively and pay no dividends. What should be the price of each stock today to be consistent with the expected return levels.
b.
C.
Determine how to you identified if Stock D and E are overvalued, fairly valued and undervalued?
d. Suppose the risk premium for factor 1 as computed in (a) increases by 0.25 percent, what will be the new expected return for D and E?
e. Suppose the risk premium for factor 1 as computed in (a) decreases by 0.25%, what will be the new expected return for D and E?
f. Devise how would you develop a Jensen Index using Arbitrage Pricing Theory. Illustrate with appropriate example.
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