XYZ stock has a standard deviation of return of 25% and the stock index has a standard deviation of return of 15%. The correlation coefficient between stock return and stock index return is 0.82. The stock is expected to pay dividend of $4 in one year and its expected price in one year is $30. The risk-free rate is 3%. The stock market index has an expected return of 12%. (1) Estimate the beta of the stock. Is the stock riskier than the stock market index? (2) Use the security market line to determine the required rate of return of the stock. (3) Determine the value of the stock. (4) If the stock has a current price of $28, what is the expected return? Would you investment in the stock?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
XYZ stock has a standard deviation of return of 25% and the stock index has a standard deviation of return of 15%. The correlation coefficient between stock return and stock index return is 0.82. The stock is expected to pay dividend of $4 in one year and its expected price in one year is $30. The risk-free rate is 3%. The stock market index has an expected return of 12%.
(1) Estimate the beta of the stock. Is the stock riskier than the stock market index?
(2) Use the security market line to determine the required
(3) Determine the value of the stock.
(4) If the stock has a current price of $28, what is the expected return? Would you investment in the stock?
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