59533341-FM11-Ch-07-Instructors-Manual-1

One category of nonconstant growth stock is a

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Unformatted text preview: ant rate forever. One category of nonconstant growth stock is a ³supernormal´ growth stock which has one or more years of growth above that of the economy as a whole, but at some point the growth rate will fall to the ³normal´ rate. This occurs, generally, as part of a firm¶s normal life cycle. A zero growth stock has constant earnings and dividends; thus, the expected dividend payment is fixed, just as a bond¶s coupon payment. Since the company is presumed to continue operations indefinitely, the dividend stream is a perpetuity. A perpetuity is a security on which the principal never has to be repaid. Answers and Solutions: 7 - 2 h. Equilibrium is the condition under which the expected return on a security is just › equal to its required return, r = r, and the price is stable. The Efficient Markets Hypothesis (EMH) states (1) that stocks are always in equilibrium and (2) that it is impossible for an investor to consistently ³beat the market.´ In essence, the theory holds that the price of a stock will adjust almost immediately in response to any new developments. In other words, the EMH assumes that all important information regarding a stock is reflected in the price of that stock. Financial theorists generally define three forms of market efficiency: weak-form, semistrong-form, and strongform. Weak-form efficiency assumes that all information contained in past price movements is fully reflected in current market prices. Thus, information about recent trends in a stock¶s price is of no use in selecting a stock. Semistrong-form efficiency states that current market prices reflect all publicly available information. Therefore, the only way to gain abnormal returns on a stock is to possess inside information about the company¶s stock. Strong-form efficiency assumes that all information pertaining to a stock, whether public or inside information, is reflected in current market prices. Thus, no investors would be able to earn abnormal returns in the stock market. i. Preferred stock is a hybrid--it is similar to bonds in some respects and...
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This note was uploaded on 09/14/2012 for the course MBA 341 taught by Professor Jamnadas during the Spring '12 term at LIM.

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