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QUESTION 3 (22 marks) In order to fund your retirement, you plan to invest your savings into the stock market. Your financial planner has just provided you with the following information for reference. Assume the risk-free rate is 4% and the market required return is 10%. Beta 1.6 Stock X Stock Y Current price $35 $100 1.1 Stock Z 0.5 (a) Determine the required return of Stock X based on CAPM. (3 marks) (b) Stock Y has just paid a dividend of $3.8. It is expected that Company Y will increase its yearly dividend payment by 7% in the foreseeable future. According to CAPM, is Stock Y overvalued or undervalued? Support your answer with calculations. (7 marks) (c) Stock Z has just distributed a dividend of $1. It is expected that the company will increase its dividend by 20% in the coming year and 15% in the second year. Starting from the third year, the company will maintain the dividend growth rate at 5% per year. Assume the relevant yearly discount rate is 7%. How much would Stock Z be worth today? (10 marks) (d) Suppose you own Stock Z and would like to diversify your risk by investing in one more stock. Which of the following stocks (Stock A, Stock B, Stock C or Stock D) would provide the greatest diversification effect? Explain briefly. (2 marks) Correlation coefficient -0.9 Stock Z and Stock A Stock Z and Stock B -0.4 Stock Z and Stock C Stock Z and Stock D 0.6