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Chapter 17: Q9. (page 369)

Suppose that an SML indicates that assets with a beta = 1.15 should have an average expected rate of return of 12 percent per year. If a particular stock with a beta = 1.15 currently has an average expected rate of return of 15 percent, what should we expect to happen to its price?

  1. Rise.

  2. Fall.

  3. Stay the same.

Short Answer

Expert verified

The correct option is (c): Stay the same.

Step by step solution

01

Step 1. Explanation

The average expected return for an asset rises, which means the stock is performing better in the market. The beta represents the risk of an asset, and the price is affected by the risk. The beta stock is equal to the beta of the SML indication. Thus, the price will remain the same.

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Most popular questions from this chapter

What determines the vertical intercept of the Security Market Line (SML)? What determines its slope? And what will happen to an asset’s price if it initially plots onto a point above the SML?

Suppose that you invest $100 today in a risk-free investment and let the 4 percent annual interest rate compound. Rounded to full dollars, what will be the value of your investment 4 years from now?

An investment has a 50 percent chance of generating a 10 percent return and a 50 percent chance of generating a 16 percent return. What is the investment’s average expected rate of return?

  1. 10 percent

  2. 11 percent

  3. 12 percent

  4. 13 percent

  5. 14 percent

  6. 15 percent

  7. 16 percent

Corporations often distribute profits to their shareholders in the form of dividends, which are quarterly payments sent to shareholders. Suppose that you have the chance to buy a share in a fashion company called Rogue Designs for \(35 and that the company will pay dividends of \)2 per year on that share. What is the annual percentage rate of return? Next, suppose that you and other investors could get a 12 percent per year rate of return on the stocks of other very similar fashion companies. If investors care only about rates of return, what should happen to the share price of Rogue Designs? (Hint: This is an arbitrage situation.)

Suppose that the Federal Reserve thinks that a stock market bubble is occurring and wants to reduce stock prices. What should it do to interest rates?
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