Question

Suppose you consider buying a share of stock at a price of $55. The stock is expected to pay a dividend of $6 next year and to sell then for $57. The stock risk has been evaluated at β = –0.5. c-1. Using the SML, calculate the fair rate of return for a stock with a β = –0.5.

Answer 1

The fair rate of return for a stock with a beta of -0.5 can be calculated using the SML formula. The formula is Fair rate of return = Risk-free rate + (Beta × Market risk premium).

Step-by-step explanation:

The fair rate of return for a stock with a beta (β) of -0.5 can be calculated using the Security Market Line (SML) formula. The SML formula states that the fair rate of return for a stock is equal to the risk-free rate plus the stock's beta multiplied by the market risk premium.

Let's assume the risk-free rate is 2% and the market risk premium is 5%. The formula can be written as:

Fair rate of return = Risk-free rate + (Beta × Market risk premium)

Plugging in the values, we get:

Fair rate of return = 2% + (-0.5 × 5%)

Fair rate of return = 2% - 2.5%

The fair rate of return for a stock with a beta of -0.5 is -0.5%.