LipTea Incorporated purchases raw materials and has processing plants around the world. The standard deviation of the firm's equity returns is 1.2 times as great as the market's standard deviation of returns. If the correlation of LipTea's returns with the market's is 0.80, what is the systematic risk of the firm?
A) 1.50
B) 1.20
C) 0.96
D) There is not enough information to answer this question.

Question

Quizplus · Accepted Answer

The systematic risk of the firm can be calculated using the formula: β = Cov(Ri,Rm) / Var(Rm), where β is the systematic risk, Cov(Ri,Rm) is the covariance of the returns of the firm and the market, and Var(Rm) is the variance of the market returns. Given that the correlation of LipTea's returns with the market's is 0.80, the covariance can be calculated as 0.80 * (1.2 * σm) * σm = 0.96σm^2, where σm is the standard deviation of the market's returns. The variance of the market returns is σm^2. Therefore, β = 0.96σm^2 / σm^2 = 0.96. Hence, the systematic risk of the firm is 0.96.

LipTea Incorporated Purchases Raw Materials and Has Processing Plants Around