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CFA Level I · CFA Level I Exam · The Capital Asset Pricing Model, Market Model, and Other Factor-Based Equity Models

An analyst estimates a stock's beta using a market model regression. The covariance of the stock's returns with the market's returns is 0.0360, and the standard deviation of market returns is 0.20. The estimated beta is closest to:

Beta equals covariance divided by market variance. Market variance is 0.20 squared, or 0.04, so beta is 0.0360 divided by 0.04, which is 0.90. Using the standard deviation instead of the variance would give a wrong answer of 0.18.

  1. A0.18
  2. B0.90Correct
  3. C1.80

Explanation

Market variance = 0.20^2 = 0.04. Beta = 0.0360/0.04 = 0.90. The 1.80 value divides by the standard deviation (0.0360/0.20 = 0.18 is option A) or mishandles the scale; both are wrong because variance is the required denominator.

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