The price differential,or the amount by which the market has discounted share price for risk,is calculated by
A) subtracting the book value from the residual income model book value calculated using the risk free rate.
B) subtracting the market price from the residual income model price calculated using the risk free rate.
C) multiplying the theoretical price-earnings ratio by the market price.
D) subtracting the residual income model price calculated using RE from the residual income model price calculated using the risk free rate.

Question

Quizplus · Accepted Answer

The price differential, also known as the market's discount for risk, is calculated by subtracting the market price from the residual income model price calculated using the risk-free rate. This calculation allows investors to determine the market's perception of the riskiness of a stock and assess whether it is overvalued or undervalued based on that perception. Choices A, C, and D are incorrect because they do not accurately reflect how to calculate the price differential.

The Price Differential,or the Amount by Which the Market Has