Question

You consider buying a share of stock at a price of $12. The stock is expected to pay a dividend of $1.60 next year, and your advisory service tells you that you can expect to sell the stock in 1 year for $14. The stock's beta is 1.2, rf is 15%, and E[rm] = 25%. What is the stock's abnormal return?

Answer 1

3%

Step-by-step explanation:

The computation of the abnormal return of the stock is shown below:

= Rf + Beta (Rm - Rf)

= 15% + 1.2 (25% - 15%)

= 15% + 12%

= 27%

Now actual return is

=[ $1.60 + ($14 - $12)] ÷ $12

= 0.3

= 30%

ANd, finally the abnormal return is

= 30% - 27%

= 3%