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Suppose that stocks A, B, and C all have a beta of 1 on the market. The graph below plots the Market Capitalization for a
Suppose that stocks A, B, and C all have a beta of 1 on the market. The graph below plots the Market Capitalization for a variety of stocks and their beta on a financial intermediary risk factor. Since small-cap stocks are most similar to the other non-diversifiable assets on banks' balance sheets (.e., small business loans), we find a negative relationship between firm size and a stock's beta on the financial intermediary risk factor. Size and Beta Distribution 500 Market Cap (Billions $) 300 B 200 300 -45 0.0 25 35 05 1.0 15 20 Bets Financial intermediary Using a two-factor model that includes the market and the financial intermediary risk factor, which stock SHOULD have the highest expected return? All 3 stocks should have the same expected return OB
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