Question

As a financial manager, you found that capital market is very risky and volatile. As we know that the firm's Beta (8) measures the volatility, or systematic risk, of a security, as it compares to the broader market. The higher the firm's Beta, the higher the security's risk, as it compares to the broader market. However, the shareholders of your firm heard about another firm with negative Beta, and they are confused now. The shareholders of your firm would like to know if a firm can have a negative beta. If yes, what would the expected return on such a firm be? Why? Please explain your reasoning by providing quality argument.

Answer 1

A firm can have a negative beta, which suggests that its securities move inversely with market trends, providing positive potential returns during market downturns and serving as a hedge against systematic risk.

Step-by-step explanation:

Yes, a firm can have a negative beta, which indicates that the security moves in the opposite direction of the broader market. An investment with a negative beta might increase in value when the market declines, and vice versa. The expected return on such a firm would be less affected by market movements and could provide a form of portfolio insurance during down markets, reducing risk and potentially earning returns that are not correlated with market movements.

Investors assess the riskiness of an investment through its beta. Higher beta values signify higher volatility and higher systematic risk compared to the broader market. Negative beta values, however, imply that the security can act as a hedge against market downturns, leading to potential positive returns when the market declines.

This does not necessarily mean the investment will have a lower overall expected return; rather, the risk-return profile is different and may appeal to investors seeking to diversify their portfolios and manage systematic risk.