i need help with this problem not sure how to do it can anyone explain it to me in steps.
There are few, if any, real companies with negative betas. But suppose you found one with ᵝ = - 0.25.
a. How would you expect this stock’s rate of return to change if the overall market rose
by an extra 5 percent? What if the market fell by an extra 5 percent?
b. You have $1 million invested in a well-diversified portfolio of stocks. Now you receive
an additional $20,000 bequest. Which of the following actions will yield the safest overall portfolio return?
i. Invest $20,000 in Treasury bills (which have ᵝ = 0).
ii. Invest $20,000 in stocks with ᵝ = 1.
iii. Invest $20,000 in the stock with ᵝ = - 0.25
Update:is there a formula I can use
thanks
Update 3:Okay I think I got it
a) In general, we expect a stock's price to change by the amount, beta times the change
in the market. With beta equal to -0.25, if the market rises by an extra 5%, the expected
change would be -1.25%; if the market falls an extra 5%, it would be 1.25%.
b) "Safest" implies lowest risk. Assuming the well-diversified portfolio is invested in
typical securities, the portfolio beta will be around 1. We can reduce this portfolio beta
the most if we invest the $20,000 in a stock with a negative beta. Answer (iii) is correct.
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Answers & Comments
Verified answer
If you have a negative Beta, it goes down when the overall market goes up. Up 5% means the company goes down 1.25%.
The SAFEST portfolio return is one that is 100% predictible, meaning it can not go down or up. The Treasuries would be safest, because they are not tied to the market (that is why Beta = 0)