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#### 11-(i) Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of \$40

###### Finance

11-(i)

Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of \$40. The stock will pay a dividend at year-end of \$3.00. Assume that risk-free Treasury securities currently offer an interest rate of 1.5%.

Average rates of return on Treasury bills, government bonds, and common stocks, 1900–2017 (figures in percent per year) are as follows.

 Portfolio Average Annual Rate of Return (%) Average Premium (Extra return versus Treasury bills) (%) Treasury bills 3.8 Treasury bonds 5.3 1.5 Common stocks 11.5 7.7

a. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)

b. What price should she be willing to pay for the stock today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

(ii)

A stock is selling today for \$50 per share. At the end of the year, it pays a dividend of \$2 per share and sells for \$57.

Required:

a. What is the total rate of return on the stock?

b. What are the dividend yield and percentage capital gain?

c. Now suppose the year-end stock price after the dividend is paid is \$43. What are the dividend yield and percentage capital gain in this case?

(iii)

You purchase 100 shares of stock for \$60 a share. The stock pays a \$3 per share dividend at year-end.

a. What is the rate of return on your investment if the end-of-year stock price is (i) \$57; (ii) \$60; (iii) \$66? (Leave no cells blank - be certain to enter "0" wherever required. Enter your answers as a whole percent.)

Stock Price-         Rate of Return-

57                                -

60                                -

66                                -

b. What is your real (inflation-adjusted) rate of return if the inflation rate is 4%? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Negative amounts should be indicated by a minus sign.)

Stock price-                           Rate of Return-

57                                         -

60                                         -

66                                         -

(iiii)

Consider the following scenario analysis:

 Rate of Return Scenario Probability Stocks Bonds Recession 0.20 −5 % 19 % Normal economy 0.60 20 % 10 % Boom 0.20 27 % 4 %

a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?

• No
• Yes

b. Calculate the expected rate of return and standard deviation for each investment. (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal place.)

Expected RoR              Standard Deviation

Stocks:

Bonds:

c. Which investment would you prefer?

Stocks or Bonds?

EST
USD