The market value weighted-average beta of firms included in the market index will always be ________.
A) 0
B) between 0 and 1
C) 1
D) none of these options (There is no particular rule concerning the average beta of firms included in the market index.)

Question

Quizplus · Accepted Answer

The market index is usually considered as the market portfolio, which includes all stocks in the market in proportion to their market value. Therefore, the market value weighted-average beta of firms included in the market index should always be 1. This is because beta measures the systematic risk of a stock, which is by definition equal to the systematic risk of the market. As the market is the portfolio of all stocks, its beta is defined as 1. The beta of any stock in the market is then a measure of the stock's relative systematic risk compared to the market. Since the market portfolio is market value-weighted, the beta of the market should also be market value-weighted, and therefore equal to 1.

The Market Value Weighted-Average Beta of Firms Included in the Market