Question

You consider buying a share of stock at a price of $18. The stock is expected to pay a dividend of $1.32 next year, and your advisory service tells you that you can expect to sell the stock in 1 year for $21. The stock's beta is 1.2, rf is 7%, and E[rm] = 17%. What is the stock's abnormal return?

Answer 1

Answer:

5%

Explanation:

In order to compute the abnormal return first we have to find out the actual return which is shown below:

Actual return is

= ($21 - $18 + 1.32) ÷ ($18) × 100

= 24%

And, the expected return is

= Risk free rate of return + Beta × (Market rate of return - risk free rate of return

= 7% + 1.20 × (17% - 7%)

= 7% + 1.20 × 10%

= 7% + 12%

= 19%

So, the stock abnormal return is

= 24% - 19%

= 5%