Why option (a) is wrong? & Why ABC has a higher unsystematic risk?

AI & Machine learning
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Course Name: Trading with Machine Learning: Regression, Section No: 4, Unit No: 3, Unit type: Quiz



 

If one says that the Stock ABC’s return has a beta of 1.4 and ex-post alpha of -3%, then we can interpret the following:
  • a) On risk adjusted basis: If the market returns are 10%, then Stock ABC’s returns are 14% and when the market return is 0%, Stock ABC’s return is -3%
  • b) On risk adjusted basis: If the market returns are 10%, then Stock ABC’s returns are 6% and when the market return is 0%, Stock ABC’s return is 3%
  • c) On risk adjusted basis: Stock ABC has a higher systematic risk than the market and gives an alpha of 3% when the market returns are 0%
  • d) On risk adjusted basis:Stock ABC has a higher unsystematic risk than the market and gives a negative return of 3% (i.e. -3%) when the market returns are 0%
2

Hi Levi,



Option a is wrong because if market returns were 10%, then stock ABC's returns would be 11%. And the reason for ABC to have higher unsystematic risk is beta is high. If beta is between 0 and 1 stock is correlated to market or index. If beta is above 1 then the stock is highly correlated and more volatile then the index or market.