Question

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B?

Years Market Stock A Stock B

1 0.03 0.16 0.05

2 -0.05 -0.20 0.05

3 0.01 0.12 0.05

4 -0.10 -0.25 0.05

a. bA < 0; bB = 0

b. bA = 0; bB = -1

c. bA > 1; bB = 0

d. bA > 0; bB < 0

Answer 1

Beta that is systematic risk is determined by: Rate of change of stock return to the rate of change of market return. It is the sensitivity of stock return to Market return.

Return of stock at the end of year 2= -20%
Return of stock at the start of year 1 =16%
Return of the market at the end of year 2=-5%
Return of the market at the start of year 1=3%

Beta = (-20-16)/(-5-3)
Beta of stock A form 1st year to 2nd year= 4.5
For all other periods also it is greater than 1.

Similarly beta of stock B = 0.

Answer is: c. bA > 1; bB = 0