5.Suppose the market portfolio\'s excess return tends to increase by 30% when th

Question

5.Suppose the market portfolio's excess return tends to increase by 30% when the economy is strong and decline by 20% when the economy is weak. A type S firm has excess returns that increase by 45% when the economy is strong and decrease by 30% when the economy is weak. A type I firm will also have excess returns of either 45% or -30%, but the type I firm's excess returns will depend only upon firm-specific events and will be completely independent of the state of the economy.

What is the Beta for a type S firm?

a. 1.5

b. 0.0

c. 1.0

d. 0.75

Chapter 10

Problems:

1. What is an efficient portfolio?

2. Explain why the risk premium of a stock does not depend on its diversifiable risk.

Explanation / Answer

The expected return from a security scaled up or scaled down due to the effect of beta of the respective security. If a stock has beta of 1, means equal to market then it move upward or downward equal to market.

In the given case, the stock I has no effect of market movements and its return are independent to the market movements. Thus, the beta of stock I is ‘0’.

Therefore, correct answer is option b.

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