Question

Fill in the blanks.

1. Risk reduction occurs when two stocks are ______ correlated.

2. To determine the beta of a stock, we compare the returns on the stock against the returns on the ____, generally over a period of several years.

3. Using the dividend growth model, if the value of a stock is the next dividend divided by the required return minus the growth rate, then the required return on equity is the dividend yield plus the ___.

Answer 1

1st Answer: Negatively Correlated

When stocks are negatively correlated, then the unsystematic risk is reduced. This helps portfolios to perform better as the portfolio is exposed to only systematic risk

2nd Answer: Market.

Beta is the relation between stock and market. If beta of a stock is 1, then it means that if the market increases by 1%, then stock will also increase by 1%

3rd Answer: Constant Growth Rate of Dividend

Gordon Growth Model states that

Stock Price = Dividend for next period / (Required Return - Constant Growth rate of Dividend)

Reshuffling the equation will give:

Required Return = Dividend for next period / Stock Price + Constant Growth rate of Dividend

= Dividend Yield + Constant Growth rate of Dividend