Question 1:
Required returns . Stock A has a beta of 0.80, stock B has a beta of 1.40, and stock C has a beta of -0.30. Assume the risk-free rate is 6 percent and the market return is estimated to be 14 percent.
a. Rank these stocks from the most risky too the least risky.
b. If the return on the market portfolio increases to 17 percent, what change would you expect in the required return for each of the stocks?
c If the return on the market portfolio declines by 5 percent, what change would you expect in the required return for each of the stocks?
d. If you felt that the stock market was just ready to experience a significant decline, which stock would you likely add to your portfolio? Why?
e. If you anticipated a major stock market rally, which stock would you add to your portfolio? Why?
Question 2:
Bond value and time. Pecos Manufacturing issued a 20-year bond with a 6.6 percent coupon rate, five years ago. The coupons are paid semiannually. The required return is currently 10.2 percent, where the company is certain it will remain until the bond matures in 15 years.
a. Assuming that the required return does remain at 10.2 percent until maturity, find the value of each $1,000 of par value of the bond with (1) 15 years, (2) 12 years, (3) 9 years, (4) 6 years, (5) 3 years, (6) 1 year to maturity.
b. Plot finings on a chart where time to maturity is the x axis and market value of bond is the y axis.
c. All else remaining the same, when the required return differs from the coupon rate and is assumed to be constant to maturity, what happens to the bond value as time moves toward maturity? Explain in light of the graph in b.
Common share value-constant growth. It is early January and McCracken Roofing, Inc., common shares paid a dividend of $1.20 per share last year. The company expects earnings and dividends to grow at a rate of 5 percent per year for the foreseeable future.
a. IF McCracken's shares are trading in the market for $28, and this is considered the value of the shares, what is investors' required return on the shares?
b. Now assume that the growth in McCracken's earnings and dividends will be 10 percent. McCracken's shares are trading in the market for $28, and this is considered the value of the shares. What is investors' required return on the shares?