Question

Assume the single-factor model is applied to a security that has a negative factor beta. The security will: A) always have a positive rate of return. B) have an expected return greater than the risk-free rate. C) have an actual return that equals the risk-free rate. D) have an expected return equal to the market rate of return. E) have an actual rate of return that can be positive, negative, or zero.

Answer 1

Answer: E) have an actual rate of return that can be positive, negative, or zero.

Step-by-step explanation:

When a single factor model like the Capital Asset Pricing Model is applied to a security with a negative beta, the returns shown could be negative, positive or even zero depending on the risk free rate and the market rate.

CAPM uses the aforementioned risk free rate, the market rate and the beta to calculate returns. The size of these variables could result in a return that is either negative, positive or zero.

For instance:

Beta = -1, Rf = 4%, Market rate = 7%

Return = 4% - 1 * ( 7% - 4%)

= 4% - 3%

= 1%

A positive return yet beta is negative. Return can change signs or be zero if figures are tweaked.