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6 November, 02:27

The market price of a security is $40. Its expected rate of return is 13%. The risk-free rate is 7%, and the market risk premium is 8%. What will the market price of the security be if its beta doubles (and all other variables remain unchanged) ? Assume the stock is expected to pay a constant dividend in perpetuity. (Round your answer to 2 decimal places.)

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  1. 6 November, 02:57
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    The market price of the security will be $27.37

    Explanation:

    Step 1: Determine current risk premium

    Current risk premium=Expected rate of return-risk-free rate

    where;

    Expected rate of return=13%

    risk free rate=7%

    replacing;

    Current risk premium = (13-7) = 6%

    Step 2: Determine new risk premium

    The risk premium will double if the better doubles

    New risk premium = (2*6) = 12%

    Step 3: New discount rate for the security

    New discount rate for the security=new risk premium+risk free rate

    New discount rate for the security = (12%+7%) = 19%

    Step 4: Calculate the dividend

    We can use the formula;

    Price=dividend/discount rate

    dividend = (40*13%) = Answer:

    Explanation:

    Step 1: Determine current risk premium

    Current risk premium=Expected rate of return-risk-free rate

    where;

    Expected rate of return=13%

    risk free rate=7%

    replacing;

    Current risk premium = (13-7) = 6%

    Step 2: Determine new risk premium

    The risk premium will double if the better doubles

    New risk premium = (2*6) = 12%

    Step 3: New discount rate for the security

    New discount rate for the security=new risk premium+risk free rate

    New discount rate for the security = (12%+7%) = $5.20

    Step 4: Market price of the security

    At a new discount of 19%, the security would be worth;

    5.2/0.19=27.37

    The market price of the security will be $27.37
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