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Suppose the market portfolio's excess return tends to increase by 30% when the economy is strong and decline by 20% when the economy is weak. A type S firm has excess returns that increase by 45% when the economy is strong and decrease by 30% when the economy is weak. A type I firm will also have excess returns of either 45% or -30%, but the type I firm's excess returns will depend only upon firm-specific events and will be completely independent of the state of the economy.
What is the Beta for a type S firm?
a. 1.5
b. 0.0
c. 1.0
d. 0.75
Problems:
1. What is an efficient portfolio?
2. Explain why the risk premium of a stock does not depend on its diversifiable risk.
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