Small firms will have relatively high loadings (high betas) on the SMB (small minus big) factor. a.
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a. Explain why.
b. Now suppose two unrelated small firms merge. Each will be operated as an independent unit of the merged company. Would you expect the stock market behavior of the merged firm to differ from that of a portfolio of the two previously independent firms? How does the merger affect market capitalization? What is the prediction of the Fama-French model for the risk premium on the combined firm? Do we see here a flaw in the FF model?
Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...
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a The Fama French FF threefactor model holds that one of the factors driving returns is firm size An index with returns highly correlated with firm si...View the full answer
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