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.