You are trying to estimate the ASX market risk premium from the All Ordi- naries
ID: 2780077 • Letter: Y
Question
You are trying to estimate the ASX market risk premium from the All Ordi- naries Index (AOI). You believe the market is priced using a constant growth dividend discount model. Assume that the index pays dividends annually with the first dividend of $118.00 expected in 1 year. The average payout ratio of firms in the index is 11.0% and the average return on new investment is 10.0%. If the All Ordinaries Index currently has a price of $4,720.00 and the risk free rate is 3.0%, what is the market risk premium?
(a) 8.4% (b) 5.5% (c) 7.2% (d) 3.6% (e) 9.5% The answer is 8.4%, but how to get that?
Explanation / Answer
Growth rate = Return on investment*retention ratio = 10*0.89 = 8.9% 4720 = 118/(r-g) r-0.089 = 118/4720 r = 118/4720+0.089 = 11.40 Market risk premium = r - risk free rate = 11.40 - 3.00 = 8.4% (Remember beta of the market is 1) Answer: Option [a]
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.