Question

1. Suppose that the price of Goldman Sachs stock is currently $142 per share. You expect that the firm will pay a dividend of $1.40 per share at the end of the year, at which time you expect that the stock will be selling for $160 per share. Also, suppose other than stock trading, you have an opportunity to earn 8% rate of return from a mutual fund which is in general safer than stocks. Should you buy the stock or buy the mutual fund? Briefly explain and show your work. (20 points)

Answer 1

This depends on the risk apetite of the investor and the certainity associated with GS' share price and the return from the mutual fund.

If one invests $142 in the GS stock then end of the year, the investor will have a return of

((final price - buying price)+dividend)/buying price = ((160-142) + 1.4)/142 = 13.66%

This is a much higher return than the 8% return from a mutual fund.

If one is risk averse then it is safer to invest in the mutual fund. However, if one has some certainty that the GS stock will appreciate then one can buy the GS stock.