The beta coefficient for Stock C is b_C = 0.3, and that for Stock D is b_D = – 0.4. (Stock D’s beta is negative, indicating that its rate of return rises whenever returns on most other stocks fall. There are very few negative-beta stocks, although collection agency and gold mining stocks are sometimes cited as examples.)

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1. If the risk-free rate is 7%and the expected rate of return on an average stock is 10%, what are the required rates of return on Stocks C and D? Round the answers to two decimal places.
   1. r_C =  %u2009%
   2. r_D =  %u2009%
2. For Stock C, suppose the current price, P₀, is $25; the next expected dividend, D₁, is $1.50; and the stock’s expected constant growth rate is 4%. Is the stock in equilibrium? Explain, and describe what would happen if the stock is not in equilibrium.
   -Select- I II III IV V Item 3

I. In this situation, the expected rate of return = 7.90%. However, the required rate of return is 10%. Investors will seek to buy the stock, raising its price to $38.46. At this price, the stock will be in equilibrium.
II. In this situation, the expected rate of return = 10%. However, the required rate of return is 7.90%. Investors will seek to buy the stock, raising its price to $38.46. At this price, the stock will be in equilibrium.
III. In this situation, the expected rate of return = 10%. However, the required rate of return is 7.90%. Investors will seek to sell the stock, raising its price to $38.46. At this price, the stock will be in equilibrium.
IV. In this situation, the expected rate of return = 7.90%. However, the required rate of return is 10%. Investors will seek to sell the stock, raising its price to $38.46. At this price, the stock will be in equilibrium.
V. In this situation, both the expected rate of return and the required rate of return are equal. Therefore, the stock is in equilibrium at its current price.

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