RISK AND RATES OF RETURN ADDITIONAL PROBLEMS

• Positive Beta


  Asset moves in the same direction as the market
• Negative Beta


  Asset moves in the opposite direction as the market
• Beta of a risk-free asset

  Zero, because the risk-free asset's covariance and the market are zero
• Negative beta


  • Investment tends to increase in price when the general market price falls and vice versa
  • Example: Securities Lending
• If Beta is negative


  Cost of equity < Risk-free rate
• For any company, there would be a finite amount of risk (default risk, liquidity risk, etc). So for a common stock, it is unlikely to see negative beta
• Some investors argue that gold should have negative betas because they tend to do better when the stock market declines
• Beta


  • Measure of risk, integral part of the CAPM
  • A company with a higher beta has greater risk and also greater expected returns
• Negative Beta


  • Indicates a negative correlation to the market
  • A stock with a beta of -0.5 is expected to go up 0.5% for every 1% decrease in its underlying index (market)
  • A stock with a Beta of -2.0 is expected to go down 2% if the index goes up 1%
• Positive beta


  Associated with a tendency of the portfolio to move in the same direction as the market
• Negative beta


  Associated with the expectation that a portfolio will move in the opposite direction of the market
• Beta close to zero


  Indicates the portfolio is not influenced by the market's direction
• High-beta stocks


  Riskier but provide higher return potentials
• Low-beta stocks


  Pose less risk but also lower returns
• Beta above 1.0


  Stock will have greater volatility than the market
• Beta less than 1.0


  Stock indicates lower volatility
• Volatility is usually an indicator of risk, and higher betas mean higher risk, while lower betas mean lower risk