A security has a beta of 0.8; the riskless rate is 4%, and the expected market...
A security has a beta of 0.8; the riskless rate is 4%, and the expected market risk premium is 6% per year. The dividend for this security next year is anticipated to be $2.00 per share; the dividend is expected to grow at 3% in perpetuity. The stock is currently trading at $38 a share.
If the CAPM is true, is the security in equilibrium?
Homework Answers
Based on CAPM,
Expected return on stock = Risk free rate + Beta * Market risk premium
Expected return on stock = 4% + 0.8 * 6% = 8.8%
Based on constant growth dividend discount model,
Given the stock is currently traded at $38 per share, hence security is not in equilibrium.
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