Assume that you are about to select a specific stock that will perform well in r
ID: 2785209 • Letter: A
Question
Assume that you are about to select a specific stock that will perform well in response to an expected run-up in the stock market. You are very confident that the stock market will perform well in the near future. Recently, a friend recommended that you consider purchasing stock of a specific firm because it had decent earnings over the last few years, it has a low beta (reflecting a low degree of systematic risk), and its beta is expected to remain low. You normally rely on beta as a measurement of a firm’s systematic risk. Should you seriously consider buying that stock? Explain.
Explanation / Answer
As you are willing to select a specific stock that will perform well in response to an expected run-up in the stock market and you are very confident that the stock market will perform well in the near future therefore you will not follow the strategy recommended by your friend.
Instead of investing in low-beta stock, you should invest high beta stocks that would be more sensitive to market conditions so that you can benefit from the expected market run-up. Stock with higher beta fluctuate more in comparison of the market (if beta of stock is more than 1) and have potential for higher returns than market at the time of run-up in the stock market.