Question

Which of the following statements is CORRECT?

Select one:

a. Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.

b. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively
correlated with returns on most other stocks during that 5-year period.

c. Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your
high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move.

d. You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should rebalance your portfolio to include more high-beta stocks.

e. If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.

Answer 1

Option D is correct

a is incorrect because beta should be negative as it performs better in recession i.e, negatively correlated with market

c is incorrect because if market will rise then high beta will rise more than low beta hence you should buy high beta and sell low beta

e is incorrect because when risk free rate declines and market risk premium is constant both high and low beta stocks will require lesser return

b is incorrect because we cannot say for sure

Hence, Option d) is correct because as risk aversion increases risk premium increases and hence higher beta benefit more than lower beta