Which of the following statements is most correct?
A) Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis, while the other has a beta of -0.6. The returns on the stock with the negative beta will be negatively correlated with returns on most other stocks in the market.
B) Suppose you are managing a stock portfolio, and you have information which leads you to believe that the stock market is likely to be very strong in the immediate future, i.e., you are confident 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.
C) 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.
D) Statements a and b are true.
E) Statements a and c are true.

Question

Quizplus · Accepted Answer

The statement in option A is true. The negative beta of a stock indicates that it moves in the opposite direction of the overall market, and hence, its returns will be negatively correlated with the returns of most other stocks in the market. The beta value only shows the sensitivity of the stock to the market movements, and not its correlation with other stocks. Option B is incorrect because in a strong market, high beta stocks tend to outperform low beta stocks. Option C is incorrect because a high beta value indicates higher volatility and sensitivity to market movements, which may not necessarily be the case for Collections Inc. during a recession.

Which of the Following Statements Is Most Correct