NEWSWIRE - October 4, 1999
Topic: Risk and Return, Stock Valuation.
Source: "How Much Higher Can the Market Go?," by Burton
G. Malkiel, Wall Street Journal, Wednesday, September 22,
1999, page A21.
Synopsis of Article: The
article is a review of the book Dow 36,000 by James K.
Glassman and Kevin A. Hassett. This book has received a lot of
attention from the press in the last couple of weeks. The premise
of the book is that the equity market risk premium has declined
(possibly to zero) because the risk of long-term bonds has become
the same as the risk on stocks. Several other authors, including
Burton Malkiel, question the validity of this premise. The article
offers an opportunity to discuss the current financial environment
and the importance of, and difficulty of estimating, the market
risk premium for valuation purposes.
- What is the equity market risk premium? What is a
conventional estimate of the premium?
- How could the equity market risk premium be zero?
- Suppose that the current long-term U.S. Treasury bond
rate is 6 percent. Also suppose that ABC Corporation paid a
dividend last year of $1.00 per share, and that this dividend
is expected to grow at a constant annual rate of 5 percent in
the future. ABCís beta is 1.0. Estimate the market value
per share of ABC assuming that the equity market risk premium
is 7 percent. Now estimate the market value per share of ABC,
assuming that the equity market risk premium is zero. Discuss
your results.
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