Question

Consider a security of which we expect to pay a constant dividend of $18.49 in perpetuity....

Consider a security of which we expect to pay a constant dividend of $18.49 in perpetuity. Furthermore, its expected rate of return is 20.1%. Using the equation for present value of a perpetuity, we know that the price of the security ought to be , where D is the constant dividend and k is the expected rate of return.
Assume that the risk-free rate is 3%, and the market risk premium is 6.4%. 

What will happen to the market price of the security if its correlation with the market portfolio doubles, while all other variables, including the dividend, remain unchanged?

Homework Answers

Answer #1

Please find below solution.. let me know if you need any clarification..

Answer 1) Using the equation for present value of a perpetuity, we know that the price of the security ought to be ,
Price = Annual dividend/required rate
=18.49/20.1%
      91.99
Answer 2) we have to use CAPM to compute required rate
As per CAPM required rate = risk free rate + Market risk premium *beta
Risk free rate 3%
Market risk premium 6.40%
Beta 2
therefore required rate = 3%+6.4%*2 15.80%
therefore price today = 18.49/15.8%     117.03
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