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You consider buying a share of stock at a price of $10. The stock is expected to pay a dividend of $1.00 next year, and your advisory service tells you that you can expect to sell the stock in 1 year for $12. The stock's beta is 1.0, rf is 16%, and E[rm] = 26%. What is the stock's abnormal return? rev: 03_30_2019_QC_CS-164617 Multiple Choice 4% 10% 6% 0%

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Answer: 4%

Explanation:

Abnormal returns are the excess actual returns received over the expected return.

The actual return can be calculated as;

= [tex]\frac{New Stock price + dividends - Old Stock Price}{Old stock price}[/tex]

= [tex]\frac{12 - 10 + 1}{10}[/tex]

= 30%

The expected return according to CAPM;

Expected return = Risk free rate + beta( market return - risk free rate)

= 16% + 1 ( 26% - 16%)

= 26%

Abnormal return = 30% - 26%

= 4%

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