Question

Indicate if the following statements are true or false. Explain your reasoning. A. If two stocks...

Indicate if the following statements are true or false. Explain your reasoning.

A. If two stocks have the same beta they must also have the same standard deviation.

B. The expected free cash flows of two all-equity firms, Firm A and Firm B, are the same. The expected return on the stock of Firm A is higher than the expected return on the stock of Firm B. Firm B is more valuable.

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Answer #1

A. FALSE. Beta measures the systematic risk and the standard deviation measures the total risk. So, if two stocks have the same beta, they do not have the same standard deviation as the idiosyncratic risk component is missing and we cannot conclude that the standard deviation is same .

B. FALSE. No, the free cash flow might not be the same, as the CAPEX, changes in working capital and EBIT might be different for the two firms.

FALSE. Yes, if the expected return is greater than required return then the stock is more valuable. Simply by comparing the expected return for two stocks ,we cannot reach a conclusion.

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