Question

Which of the following statements is CORRECT?

a. Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move.
b. Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.
c. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of %u22120.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.
d. If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.
e. You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should rebalance your portfolio to include more high-beta stocks

Answer 1

Answer: C. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of %u22120.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.

Step-by-step explanation:

From the options given, the correct option is option C "Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of %u22120.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period".

Option A is wrong because when there is information that a particular stock will be strong in the future, one should not sell your high-beta stocks and buy low-beta stocks rather the low best stocks should be sold and high beta stocks should be bought.

Option B is wrong because during recession, collections' revenues, profits, and stock price tend to fall and not rise. During recession, there is decrease in economic growth, unemployment and other negative effects in the economy.

Option D and E are wrong as well as the reverse is the case in both situations. The correct option is C.