Question

The current price of stock Fast-Value (FV) is $100. In a year when the market is up, the price of FV is expected to increase to $120. While when the market is down, the price is expected to decline to $90. The probability of an up market in a year is 60% while the probability of a down market is 40%. FV expects to pay a dividend of $2 in either market condition. The T-bill rate is 3%. What is the expected return on FV?

A. 8%

B. 9%

C. 10%

D. 7%

Answer 1

We have given two scenarios of economy Up and down

Weighted price = W1R1 + W2R2

Where, W1 is probability of Market up

W2 is probability of market down

R1 is price when market is up

R2 is price when market is down

= 60% × 120 + 40% × 90

= $108

So, Return = (Price at the end - price at beginning) / price at beginning

= (108 - 100) / 100

= 8%

The company also declared dividend $2

Dividend percentage = Dividend / Face value

= 2 / 100

= 2% or 0.02

Total return = Dividend return + Stock return

= 8% + 2%

= 10%

Option C is the correct answer.