CFA Practice Question

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CFA Practice Question

A company's required rate of return is 17.6%. An analyst expects the company to pay $14 in dividends next year. The company's stock is currently trading at $70 and is expected to fall to $68 by the year-end. The alpha of the company is

A. 0.
B. -0.5%.
C. 0.5%.
Correct Answer: B

Expected holding period return is the sum of dividend yield and price appreciation: r = D1/P0 + (P1 - P0)/P0 = 14/70 + (68 -70)/70 = 0.171.
Alpha equals the difference between this expected holding-period return and the required rate of return: alpha = 17.1% - 17.6% = -0.5%.

The negative value of alpha indicates that the stock is not an attractive stock for investors with a single-period horizon.

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