Question

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 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 I and Type S firms?

Answer 1

Answer: Beta for type I = 0

Beta for type S = 1.5

Explanation:

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’.

Beta for type S = [45-(-30)]/[30-(-20)]

= 75/50 = 1.5