You consider buying a share of stock at a price of $25

Finance Dec 10, 2020

You consider buying a share of stock at a price of $25. The stock is expected to pay a dividend of $1 next year, and your advisory service tells you that you can expect to sell the stock in 1 year for $29. The stock's beta is 1.5, risk free rate is 4%, and Expected Market Return is 15%. What is the stock's alpha?

Expert Solution

buying price = 25

selling price in 1 year =29

dividend received =1

Stock actual return formula = (Stock price in 1 year or selling price - buying price today+dividend received)/buying price today

=(29-25+1)/25

=0.20 or 20%

required return of stock formula as per CAPM = Risk free rate +(beta*(expected market return - risk free rate))

=4%+(1.5*(15%-4%))

=0.205 or 20.5%

Alpha of stock formula = Actual return - required return

=20%-20.5%

=-0.50%

So Alpha of stock is -0.50%

Archived Solution

Unlocked Solution

You have full access to this solution. To save a copy with all formatting and attachments, use the button below.

Already a member? Sign In

Important Note: This solution is from our archive and has been purchased by others. Submitting it as-is may trigger plagiarism detection. Use it for reference only.

For ready-to-submit work, please order a fresh solution below.

Or get 100% fresh solution

Get Custom Quote