You expect the risk-free rate to be 3.5% and the market return to be 9%. You also have the following information about share X: CurrentExpectedExpectedShareBetaPricePriceDividendX2$34$36$0 What are the estimated rates of return (based on their current price, expected price and dividend), the required (expected) rate of return (based on systematic risk), and what is your decision on this share (buy, sell or hold)?Group of answer choicesEstimated return = 4.5%; Required (expected) return = 6.1%; SellEstimated return = 8.5%; Required (expected) return = 7.5%; BuyEstimated return = 14.5%; Required (expected) return = 5.9%; BuyEstimated return = 5.9%; Required (expected) return = 14.5%; Sell
Question
You expect the risk-free rate to be 3.5% and the market return to be 9%. You also have the following information about share X: CurrentExpectedExpectedShareBetaPricePriceDividendX236$0 What are the estimated rates of return (based on their current price, expected price and dividend), the required (expected) rate of return (based on systematic risk), and what is your decision on this share (buy, sell or hold)?Group of answer choicesEstimated return = 4.5%; Required (expected) return = 6.1%; SellEstimated return = 8.5%; Required (expected) return = 7.5%; BuyEstimated return = 14.5%; Required (expected) return = 5.9%; BuyEstimated return = 5.9%; Required (expected) return = 14.5%; Sell
Solution
First, let's calculate the estimated rate of return. The formula for this is (Expected Price - Current Price + Dividend) / Current Price. Plugging in the given values, we get:
Estimated return = ((36 - 34) + 0) / 34 = 0.0588 or 5.88%
Next, let's calculate the required (expected) rate of return. The formula for this is Risk-free rate + Beta * (Market return - Risk-free rate). Plugging in the given values, we get:
Required return = 3.5% + 2 * (9% - 3.5%) = 14%
Comparing the estimated return and the required return, we see that the estimated return is less than the required return. This means that the share is overvalued, and the decision would be to sell.
So, the correct answer is: Estimated return = 5.88%; Required (expected) return = 14%; Sell.
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