Interest rates & stocks Essay Example | Topics and Well Written Essays - 500 words

Interest rates & stocks - Essay Example By using these values the current price of XYZ stock has been calculated and it is equal to $12.85. Po is the actual share price and P is the calculated stock price and when these two prices are compared, there is a huge difference between the two prices as the value of Po is equal to $76.28 and value of P is $12.85. There can be several reasons for the difference between the actual price of XYZ stock and the calculated price. One major reason could be the difference between the demand and supply of stock as in reality the demand of XYZ stock would be very high which might have increased the actual price of the stock and for this reason the stock has been overvalued. Also the other reason might be that people might expect the company to perform better in future and this is the reason why they would like to buy the stock of XYZ and this would have increased the price of the stock as well. As the market risk premium has increased from 7.5% to 10%, so this would change the return of XYZ stock as well. The new return can be found using CAPM equation and the new required return with the changed market risk premium would be 18.525%. By using the value of new required return of XYZ stock in Constant Growth Model the value of XYZ’s share price has been calculated. The new price is $7.75. The new price is lower than the price calculated previously because the market risk has increased and investors would like to have more return on the stock. So in order to get more return either the return or dividend should increase or the price of the stock should decrease, since dividend is constant therefore the price of the stock has decreased. The share price of XYZ Company calculated using the P/E method is different than the share price calculated using constant growth model and the reason behind this difference in estimated share price is that these methods are used to estimate the share price and at times one method would give