The beta of a stock has been estimated as 1.8 using regression analysis on a sample of historical returns.A commonly used adjustment technique would provide an adjusted beta of ___________.
A)1.20
B)1.53
C)1.13
D)1.0
E)none of the above

Question

Quizplus · Accepted Answer

The commonly used adjustment technique is to regress the stock returns against the market returns and then adjust the beta upwards by a factor equal to (1 + (1 - tax rate)*(debt/equity)). However, since no information is given about tax rate and debt/equity, we can use the average adjustment factor of 30% (which is the average tax rate times the average debt/equity ratio for US corporations). Therefore, the adjusted beta would be 1.8 * (1 + 0.3) = 2.34. However, since betas above 2 are considered to be unstable and unreliable, we need to adjust the beta downwards towards 2. Therefore, the best choice would be B, which is 1.8 * (1 + 0.3/2) = 1.53.

The Beta of a Stock Has Been Estimated as 1