Certified Valuation Analyst (CVA) Practice Exam

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If a stock has a beta of 1.4 and the market decreases by 10%, what is the expected change in the stock's price according to CAPM?

  1. Be down 10%

  2. Be down 14%

  3. Be up 10%

  4. Be unchanged

The correct answer is: Be down 14%

To determine the expected change in a stock's price using the Capital Asset Pricing Model (CAPM), we need to understand the concept of beta. Beta is a measure of a stock's volatility in relation to the overall market. A beta of 1.4 indicates that the stock is expected to be 40% more volatile than the market. In this scenario, if the market decreases by 10%, we can calculate the expected change in the stock's price by multiplying the market's change by the stock's beta. Specifically, you would take the negative change in the market (which is -10%) and multiply it by the beta value of 1.4. The calculation is as follows: Expected change in stock price = Beta × Change in market Expected change in stock price = 1.4 × (-10%) Expected change in stock price = -14% This means the stock is expected to decrease by 14% as a result of the 10% decrease in the market, reflecting its higher sensitivity to market movements due to its beta being greater than 1. Thus, the answer indicating the stock will be down 14% captures the relationship between market changes and the expected movement in this particular stock's price accurately.

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