Question

Which of the following statements is (are) correct?(x)If the risk-free rate is 10 percent and the market risk premium is 4 percent, then the required return for the market is 6 percent.(y)Suppose the annual return on the S&P 500 Index was 8.4 percent. If the annual T-bill yield during the same period was 2.7 percent then the market risk premium during that period is 5.7 percent.(z)Suppose the annual return on the S&P 500 Index was 10.8 percent. If the market risk premium during the same period was 6.9 percent then the risk-free rate during that period is 3.9 percent.

.(x), (y) and (z)B.(x) and (y) onlyC.(x) and (z) onlyD.(y) and (z) onlyE.(z) only

Samsung recently adjusted the probabilities for its expected cash flows in light of an Asian currency crisis. It revised the probability of favorable conditions from 32% to 18% and the probability of poor earnings from 7% to 17%. Which of the following is the most likely result from this revision?

A. It would lower its historical return.

B. The probabilities cannot be revised once they have been estimated.

C. It would have no effect on expected returns.

D. It would raise expected returns.

E. It would lower expected returns

. Which of the following statements is (are) correct?

(x)The stocks of small companies that are priced below $1 per share are known aspenny stocks.

(y)A stock market bubble occurs when investor enthusiasm causes an inflated bull market that drives prices too high, ending in a dramatic collapse in prices.

(z)A price bubble can occur for a single stock.

A.(x), (y) and (z)B.(x) and (y) onlyC.(x) and (z) onlyD.(y) and (z) onlyE.(z) only

Answer 1

1. The correct answer is A (x,y and z). Risk premium = Market rate of return - Risk free rate of return.

In x, Risk premium = Rm - Rf

          4 %            = ? - 10%

by solving we will get Rm = 6%

In z, Risk premium = Rm - Rf

          ?            = 8.4% - 2.7%

by solving we will get Risk premium = 5.7%

In y, Risk premium = Rm - Rf

          6.9$            = 10.8% - ?

by solving we will get Risk free rate of return = 3.9%

2. The correct answer is E (It would lower the expected returns). This is because of the revision of probability of cash flow to the downside and revision of poor earnings on the upside, which will result in lower value of company's share in market and hence a lower expected return.

3. The correct answer is A (x,y and z). Shares with price of less than $1 are regarded as penny stocks (x) The definition of stock bubble in (y) is correct.The bubble in price can occur for both stock market in general and for a individual stock as well (z).