The beta coefficient for Stock C is bC = 0.4, whereas that for Stock D is bD -0.5. (Stock D's beta is negative, indicating that its rate of return rises whenever returns on most other stocks fall. There are very few negative beta stocks, although collection agency stocks are sometimes cited as an example.)
a. If the risk-free rate is 9 percent and the expected rate of return on an average stock is 13 percent, what are the required rates of return on Stocks C and D?
b. For Stock C, suppose the current price, P0, is $25; the next expected dividend, D1, is $1.50; and the stock's expected constant growth rate is 4 percent. Is the stock in equilibrium? Explain, and describe what will happen if the stock is not in equilibrium.