Question

Alexis determines that the standard deviation of her SafeBet stock is 25% per year. She knows the standard deviation of a broad market index is 10% per year. If the correlation coefficient between SafeBet and the market index is 0.4, Alexis will find that, on average:

		SafeBet provides a much greater return than the market for a given positive increase in market return
		SafeBet provides a reduction in negative returns when the market as a whole declines
		SafeBet's return will move by 0.4 percent when the market moves by 1 percent
		SafeBet's return will move by 1 percent when the market moves by 1 percent
		SafeBet's return will move by 40 percent when the market moves by 1 percent

Answer 1

Standard deviation of the SafeBet stock = σS = 25%

Standard deviation of the market = σM = 10%

Correlation coefficient between SafeBet and Market = ρ = 0.4

We will calculate the Beta of the stock. The beta of the stock is calculated using the formula:

Beta of SafeBet = βS = (ρ*σS)/σM = (25%*0.4)/10% = 1

Beta represents the movement of the stock price with respect to the broad market index. We also know that the beta of the market is 1. SafeBet also has a beta of 1, this means that the volatility of the price movement of the SafeBet stock is similar to that of the broad market index. Hence, we can say that SafeBet's return will move by 1 percent when the market moves by 1 percent

Answer -> SafeBet's return will move by 1 percent when the market moves by 1 percent