money & banking

2. Suppose that the required return for a particular stock is 10%. Assume that stock paid a dividend of $100 annually but that the growth rate of dividends was zero. a. (5 points) According the Gordon model of stock prices, what is the price of the stock? What is the expected pay-off from owning that stock one period (i.e. the amount of income that stock could generate next period)? Show work. b. (5 points) Now suppose new information arrives in the market and that market participants expect the payoff from owning that stock increases to $1210. Assume the new information does not lead market participants to change their required return on the stock. Based on this new information, is the stock over or undervalued based at its initial price? Show work. c. (5 points) According efficient markets hypotheses, what will be the current price of the stock once the market has taken into account this new information? Show work. d. (5 points) What if instead of the increase in expected payoff as in part b, investors revised their beliefs about the riskiness of that stock downward so that the required return fell to 5%. Based on this new belief, what would be the new price of the stock? Show work