Reference no: EM1311608

Computation of value of shares

To invest your year-end bonus, you are considering three investment opportunities, imaginatively named Security A, Security B, and Security C. Security A is expected to pay $100 a year for the first 5 years, $400 a year for the next 10 years, and nothing after that. B is expected to pay $300 a year for the first 8 years, $200 a year for the next 7 years, and nothing thereafter. Security C is expected to pay a growing amount every year forever. Starting next year, security C will pay $150 and that amount will grow at a 2% per year. The expected return for the three investments is 10%.

(a) If all the three securities were traded on a market, what would be their market prices?

(b) If all the three securities are trading at the market prices calculated above, which investment do you prefer? Explain.

(c) What will happen to the expected return if investors suddenly become less conservative and more willing to bear risk? What would happen to stock prices if this occurred? Could this be a reason for the 204 points rise in Dow yesterday? Explain.