Question

questions 9 & 10

9. You have just bought IBM stock. Your total investment was $100. You will hold it for one year and then sell. You expect to make 10% on your investment that is you expect to have $110 after one year. You leur private information that one of IBS projects, which was expected to pay off three years from now, is now not going to pay off after all. This news will definitely be public by tomorrow. Assuming that you will still sell the stock one year from today, the return you expect to make on your investment is now: will still sell ell. This news ed to pay of beteren private information (a) The same as it was before, i.e., 10% (b) Lower than 10% (c) Higher than 10% 10. All the assumptions of the CAPM hold. All investors hold a mean-variance efficient portfolio. You observe two stocks. These stocks are expected to pay $100 one year from now and then die. The stocks have the following characteristics Stock Beta Standard deviation X 1.5 20 Y 0. 5 50 Which stock do you think should have the higher price? (a) Stock X, because it has the higher beta (b) Stock Y, because it has the higher SD (c) Stock X, because it has the lower SD (d) Stock Y, because it has the lower beta

Answer 1

9.

Expected Return on IBM Stock before learning about the private information = 10%

The private information states that one of the company's project which was expected to pay after 3 years is not going to pay off after all. This is a bad news which is going to affect the Stock Price adversely.

A Stock price is the Present Value of the future profits which the company is expected to earn.

Hence, even if the payment was expected to be received after 3 years, the impact on the Stock Price will take place immediately.

Hence, the total return which we expect to make after one year will be lower than 10%, because of this adverse news.

Correct Answer is Option B - Lower than 10%