Download Financial Markets and Investments: Practice Problems - Prof. John M. Krieg and more Assignments Banking and Finance in PDF only on Docsity! Chapter 8 Practice Problems 1. A stock that sells for $100 entitles you to a dividend payment of $4. You estimate that the growth rate of the firm’s dividends is about 2 percent per year and that the risk-free rate is 3.5%. What is the risk premium suggested by the stock? Does it strike you as high or low? 2. As you flip through The Wall Street Journal you notice advertisements by investment firms wanting you to buy their products. Common among all of the ads is the claim that the firm has a track record of performing above average. Explain how they can all be above average. Is this inconsistent with the efficient markets theory? 3. What are the advantages of holding stock in a company versus holding bonds in the same company? 4. You are trying to decide whether to buy stock in Company X or Company Y. Both companies need $1,000 capital investment and will earn $200 in good years (with probability .5) and $60 in bad years. The only difference between the companies is that Company X is planning to raise all of the $1,000 needed by issuing equity while Company Y plans to finance $500 through equity and $500 through bonds on which 10 percent interest must be paid. In which company would you buy stock? Explain your answer. 5. Based upon the fundamental model of stock prices, what do you think would happen to stock prices if there were an increase in the perceived riskiness of bonds? 6. “If stock prices did not follow a random walk, there would be unexploited profit opportunities in the market.” Is this statement true, false, or uncertain? Explain. 7. If the public expects a corporation to lose $5 a share this quarter and it actually loses $4, which is still the largest in company history, what does the efficient market hypothesis say should happen to the price of the stock when the $4 loss is announced? 8. If your broker has been right in her 5 previous buy and sell recommendations, should you continue listening to her for advice? 9. You are thinking about investing in stock in a company who paid a dividend of $10 this year and whose dividends you expect to grow at 4% a year. The risk free rate is 3% and you require a risk premium of 5%. If the price of the stock in the market is $200 a share, should you buy it?
