Changes in a Stocks Beta Coefficient

As we shall see later in the book, a firm can influence its market risk, hence its beta, through changes in the composition of its assets and also through its use of debt. A company's beta can also change as a result of external factors such as increased competition in its industry, the expiration of basic patents, and the like. When such changes occur, the required rate of return also changes, and, as we shall see in Chapter 5, this will affect the firm's stock price. For example, consider MicroDrive Inc., with a beta of 1.40. Now suppose some action occurred that caused MicroDrive's beta to increase from 1.40 to 2.00. If the conditions depicted in Figure 3-12 held, MicroDrive's required rate of return would increase from 13 to 16 percent:

FIGURE 3-14 Shift in the SML Caused by Increased Risk Aversion

FIGURE 3-14 Shift in the SML Caused by Increased Risk Aversion

Sml Graph Risk Free Rate Change

As we shall see in Chapter 5, this change would have a dramatic effect on MicroDrive's stock.

Differentiate among the expected rate of return (r), the required rate of return (r), and the realized, after-the-fact return (r) on a stock. Which would have to be larger to get you to buy the stock, r or r? Would r, r, and r typically be the same or different for a given company?

What are the differences between the relative volatility graph (Figure 3-9), where "betas are made," and the SML graph (Figure 3-12), where "betas are used"? Discuss both how the graphs are constructed and the information they convey.

What happens to the SML graph in Figure 3-12 when inflation increases or decreases?

What happens to the SML graph when risk aversion increases or decreases? What would the SML look like if investors were indifferent to risk, that is, had zero risk aversion?

How can a firm influence its market risk as reflected in its beta?

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Responses

  • raimondo
    What happens to the sml graph when risk aversion increases or decreases?
    8 years ago
  • COREY
    What happens to the SML Graph When investors risk aversion increase of decrease ?
    8 years ago
  • jaana
    How is stock beta constructed?
    7 years ago
  • sadoc
    How can a firm influence it’s market risk as reflected in its beta?
    6 years ago
  • marvin
    How can a company effect its beta?
    3 years ago
  • reeta
    What happens to the SML graph in Figure 312 when inflation increases or decreases?
    3 years ago
  • manuela
    How can a firm change its beta?
    1 year ago
  • cherryl
    What happens to beta when risk aversion increases?
    1 year ago
  • fosco
    How changes in capital structure affect beta?
    11 months ago
  • Gofreddo
    Is beta change with change in capital structure?
    8 months ago

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