Question

Betas Answer the following questions for assets W to Z shown in the table.Asset Beta

W 0.90 X -0.60 Y 1.80 Z 2.30

a. What impact would a 10% decrease in the market return be expected to have on each asset’s return? b. What impact would a 10% increase in the market return be expected to have on each asset’s return? c. If you believed that the market return would decrease in the near future, which asset would you prefer? Why? d. If you believed that the market return would increase in the near future, which asset would you prefer? Why?

Answer 1

In summary, a 10% decrease in the market return would impact assets proportionally to their betas. For a decrease, lower beta assets are preferred, such as X. Conversely, for an increase, higher beta assets like Z are preferred. The preference depends on the investor's outlook on market movements.

a. The impact of a 10% decrease in the market return on each asset's return can be calculated using the asset beta. The formula for the expected return change is given by:

Expected Return Change = Beta × Market Return Change

For each asset:

W's Return Change = 0.90 × (-10%)

X's Return Change = (-0.60) × (-10%)

Y's Return Change = 1.80 × (-10%)

Z's Return Change = 2.30 × (-10%)

b. Similarly, the impact of a 10% increase in the market return on each asset's return is calculated using the same formula. For each asset:

W's Return Change = 0.90 × 10%

X's Return Change = (-0.60) × 10%

Y's Return Change = 1.80 × 10%

Z's Return Change = 2.30 × 10%

c. If you believe the market return will decrease, you might prefer assets with lower betas as they are expected to be less sensitive to market movements. In this case, asset X with a negative beta may be preferred.

d. If you believe the market return will increase, you might prefer assets with higher betas as they are expected to capture more of the market's upward movement. In this case, asset Z with the highest beta may be preferred.