Unsystematic risk, Risk Management

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a. What is unsystematic risk? How is it different from systematic risk? Describe the sources of unsystematic risk. What will the required rate of return be when the level of systematic
is high?

b. The risk-free rate of return is 8 percent; the expected rate of return on the market is 12 percent. Stock X has a beta coefficient of 1.3, an earnings and dividend-growth rate of 7

percent, and a current dividend of $2.40. If the stock is selling for $35, what should you do?

c. Two stocks each pay a $1 dividend that is growing annually at 8 percent. Stock A has a beta of 1.3; stock B's beta is 0.8.

i) Which stock is more volatile?

ii) If treasury bills yield 6 percent and you expect the market to rise by 12 percent, what is your risk-adjusted required rate of return?

iii) Using the dividend-growth model, what is the maximum amount you would be willing to pay for each stock?

iv) Why are your valuations different?

d. Presently, Stock A pays a dividend of $2.00 a share, and you expect the dividend to grow rapidly for the next four years at 20 percent. Thus the dividend payments will be:

Year Dividend
1 $1.20
2 1.44
3 1.73
4 2.07

After this initial period of super growth, the rate of increase in the dividend should decline to 8 percent. If you want to earn 12 percent on investments in common stock, what is the maximum you should pay for this stock?


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