Which of the following statements is FALSE?

Video: 3.C. P18-36 (Risk and return 2)

Video: 3.D. P37-52 (Cost of equity 1)

Question

Which of the following statements is FALSE?

Video: 3.C. P18-36 (Risk and return 2)

Video: 3.D. P37-52 (Cost of equity 1)

BlackTom AI · Accepted Answer

Exploring the statements about risk and return requires examining each option in the context of standard finance theory.
Option a: 'To measure the systematic risk of a stock, we must determine how much of the variability of its return is due to systematic, market-wide risks versus diversifiable, firm specific risks.' This aligns with the fundamental distinction between systematic (market) risk and diversifiable (idiosyncratic) risk, and it is precisely what beta and the CAPM framework attempt to quantify. The statement is consistent with widely accepted definitions.
Option b: 'Two stocks with identical volatility must have identical betas.' Here, a common misconception is challenged. Volatility measures total variability of a stock's returns, not how those returns co-move with the market. Beta is about covariance with the market (systematic risk) relative to market variance. Two stocks can have the same total volatility but different betas if their returns move differently with the market, so this claim is not generally true. This makes the option false.
Option c: 'The risk premium investors can earn by holding the market portfolio is the difference between the market portfolio's expected return and the risk-free interest rate.' This is the classic definition of the market risk premium in the CAPM framework: expects that investors are compensated for taking on systematic risk, measured as E[Rm] − Rf. The statement is standard and true.
Option d: 'Stocks in cyclical industries, in which revenues tend to vary greatly over the business cycle, are likely to be more sensitive to systematic risk and have higher betas than stocks in less sensitive industries.' Cyclical firms tend to have higher sensitivity to the overall economy, which translates into higher systematic risk and typically higher betas relative to non-cyclical or defensive firms. This reflects conventional risk profiling and is true.
In summary, option a is consonant with the decomposition of risk into systematic and diversifiable components, option c and d reflect standard CAPM and industry sensitivity concepts, while option b asserts a equivalence between volatility and beta that does not hold in general. This makes option b the false statement among the four.

FINANCE 351 Quiz 5 Cost of Capital

Which of the following statements is FALSE? Video: 3.C. P18-36 (Risk and return 2) Video: 3.D. P37-52 (Cost of equity 1)

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