Risk And Capital

Risk and Capital

A. Find an estimate of the risk free rate of interest.

1. DJIA 10,558.03 -52.07 -0.49%

2. NASDAQ 2,177.91 -13.41 -0.61%

3. S & P 500 1,226.42 -9.44 -0.76%

4. S & P/TSX 10,550.51 -76.20 -0.72%

5. BOVESPA 26,517.92 48.02 0.18%

6. U.S. FED FUNDS 3.50 0.06

7. U.S. FED TARGET 3.25 0.00

8. CANADIAN 10 -YR BOND 4.00 0.07

9. U.S. 10 YR TREASURY 4.39 0.07

10. U.S. GDP 07/29 3.4%

11. U.S. UNEMPLOYMENT 08/05 5.0%

12. CANADIAN UNEMPLOYMENT 08/05 6.8%

13. BRAZILIAN UNEMPLOYMENT 07/21 9.4%

Information regarding the U.S. 10 yr treasury: the risk free rate is 4.39%, market risk premium is 7.5%.

B. Downloading IBM Stock Information:

1. IBM's beta (b) : 1.666 (yahoo finance website)

2. IBM's current annual dividend : year 2004 $0.70 per share (IBM website)

3. IBM's 3 yr dividend growth rate (g) (information on dividend from IBM website)

Dividend Paid

2004 $0.70

2003 $0.63

2002 $0.59

2001 $0.55

Making the average growth rate = ($0.70/$0.55)^(1/3)-1=0.083707 or 8.37%

4. Industry P/E - 20.30 (Yahoo finance website)

5. IBM's EPS

Earnings per share of common stock from continuing operations assuming dilution: 2004 2003 2002

$4.94 $4.34 $3.07

With the information use the CAPM to calculate IBM's required rate of return or ks.

Ks = rf + risk premium *beta

= 4.39% + 7.5%*1.666 = 16.89%

Using the CGM to find the current stock price for IBM.

P0 = D1/(Ks-g)

D1 = Do*(1+g) = $0.70*(1+8.37%) = $0.75859

P0 = $0.75859/ (16.89% - 8.37%)