Question

1. 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	0.18	0.05
4	-0.10	0.25	0.05
5	0.06	0.14	0.05

What do we know about the beta of each stock?

Stock A?

Stock B?

Which stock has a higher beta?

Answer 1

Beta of a stock is defined as the volatility of stock price in relation to the market.

Based on the information given, we can see that stock A returns are volatile while stock B returns are very low volatile.

But, we also see that Stock A returns decrease when market returns increase which implies Stock A is highly volatile but also not correlated to the market.

Based on the above and definition of beta, both stock A and stock B have betas less than 1 (market beta). Since, stock A returns change inversely to market returns, Stock A has a negative beta while stock B has a positive beta less than 1.

Stock A has higher beta.