Small firms generally have relatively high loadings (high betas) on the SMB (small minus big)

factor.

a. Explain why this is not surprising.

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?

c. How does the merger affect market capitalization?

d. What is the prediction of the Fama-French 3-factor model for the risk premium on the merged firm compared to the weighted average of the two component companies?

e. Do we see here a problem in applying the FF model?

 P-69