Stocks A and B have the following data. The market risk premium is 6.0% and the
ID: 2708960 • Letter: S
Question
Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
A B
Beta= 1.10 .90
Constant growth rate= 7% 7%
Stock B could have the higher expected return.
Stock B’s dividend yield equals its expected dividend growth rate.
Stock A must have a higher stock price than Stock B.
Stock A must have a higher dividend yield than Stock B.
Stock B must have the higher required return.
a.Stock B could have the higher expected return.
b.Stock B’s dividend yield equals its expected dividend growth rate.
c.Stock A must have a higher stock price than Stock B.
d.Stock A must have a higher dividend yield than Stock B.
e.Stock B must have the higher required return.
Explanation / Answer
Option C is correct.
Both stock A and B are same in all aspects except Beta. Since beta of Stock A is higher, it would have higher required return. Both the stocks have same capital gain yield that is 7%, therefore, to provide higher required return Stock A have to have higher Dividend yield as required return is the sum of capital gain yield and dividend yield.
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