Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $45. The stock will pay a dividend at year-end of $4.00. Assume that risk-free Treasury securities currently offer an interest rate of 2.5%.

Average rates of return on Treasury bills, government bonds, and common stocks, 1900-2017 (figures in percent per year) are as follows.

Portfolio Average Annual

Rate of Return (%) Average Premium (Extra return

versus Treasury bills) (%) Treasury bills 3.8 Treasury bonds 5.3 1.5 Common stocks 11.5 7.7

a. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)

b. What price should she be willing to pay for the stock today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Assume these are the stock market and Treasury bill returns for a 5-year period:

Year Stock Market Return (%) T-Bill Return (%) 2013 35.90 0.21 2014 15.20 0.21 2015 5.10 0.21 2016 16.90 0.08 2017 25.90 0.10

Required:

a. What was the risk premium on common stock in each year?

b. What was the average risk premium? c. What was the standard deviation of the risk premium?