Question

Your boss at an investment firm states that they would like a required return of 5% on all investments. This boss then discovers a bio-tech stock that pays a $1 dividend next quarter. Your junior analyst discovers on the internet that the stock will give dividends at a rate of 5%. Given that this is the only information you have, you defy your boss and do not buy the stock, why? Explain.

Answer 1

Answer:

The boss has stated to the investment firm of his requirement of investment returns at 5 % . Bio tech stock he comes ascross gives 1 $ next quarter making 5 % return but i resist the boss not to buy the stock even if this is giving worth $ 1 return next quarter next quarter Because this is the equity investment where risk is too much . The money invested can entirely ruined and can give multifold return .It is risky to invest in to the Equity stocks . Hence the required return for the stock will be the Minimum risk free return on investment one get along with the risk premium and hence the required return will be here exceeds more than 5 % depending upon risk free return in market and risk of the stock premium will high accordingly . The more risk the more will be the premium and higher the expected rate of return and hence 5 % will not be the required return in equity as equity has risk and not safe investment .Investor would expect the reward premium for investing fund in the risky assets investments .

Hence i would resist defy the boss to invest in the Bio Tech stock at 5 % return getting in form of dividend in quarter.

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