Question

Suppose that you have been consulted on buying a stock for £ 80 today. This stock...

Suppose that you have been consulted on buying a stock for £ 80 today. This stock is expected to have a capital gain of 20% in two years. given that the beta of this stock is 2 risk free rate is 6% and market risk premium is 11%, what is the fair price of this stock? Select one: a. 76.80 b 75.00 C. 58.59 d. 71.34

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Answer #1

Buy price of Stock: £ 80 today

Expected capital gain: 20% in two years

Hence Value of share after 2 year : £ 80 + £ 80 * 20% = £ 96

Beta of the stock: 2

Risk free rate: 6%

Market risk premium:11%

Expected Return as per CAPM : Risk free rate + (Beta * Market risk premium)

Expected Return : 0.06 + ( 2 * 0.11)

Expected Return : 0.06 + 0.22

Expected Return : 0.28 or 28%

Hence,

Fair price of the stock today: Price after 2 year / ( 1 + Expected return)2

Fair price of the stock today: £ 96 / (1 + 0.28)2

Fair price of the stock today: £ 96 / 1.6384

Fair price of the stock today: £ 58.59

Correct opttion is  C. 58.59

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