Question

. Portfolio risk and return

Emma holds a $5,000 portfolio that consists of four stocks. Her investment in each stock, as well as each stock’s beta, is listed in the following table:

Stock	Investment	Beta	Standard Deviation
Andalusian Limited (AL)	$1,750	0.90	12.00%
Tobotics Inc. (TI)	$1,000	1.30	12.00%
Water and Power Co. (WPC)	$750	1.20	18.00%
Makissi Corp. (MC)	$1,500	0.40	19.50%

Suppose all stocks in Emma’s portfolio were equally weighted. Which of these stocks would contribute the least market risk to the portfolio?

Makissi Corp.

Tobotics Inc.

Andalusian Limited

Water and Power Co.

Suppose all stocks in the portfolio were equally weighted. Which of these stocks would have the least amount of stand-alone risk?

Water and Power Co.

Tobotics Inc.

Makissi Corp.

Andalusian Limited

If the risk-free rate is 7% and the market risk premium is 8.5%, what is Emma’s portfolio’s beta and required return? Fill in the following table:

	Beta	Required Return
Emma’s portfolio

Answer 1

(1)-“ Makissi Corp. (MC)” contribute the least market risk to the portfolio, since it has the lowest Beta in the Portfolio

(2)-“Andalusian Limited (AL) & Tobotics Inc. (TI)” will have the least amount of standalone risk, since it has the lowest standard deviation of returns

Emma’s Portfolio Beta

Portfolio Beta = Sum(Beta x Percentage of the Portfolio)

= [0.90 x ($1,750/$5,000)] + [1.30 x ($1,000/$5,000)] + [1.20 x $750/$5,000)] + [0.40 x ($1,500/$5,000)]

= [0.90 x 0.35] + [1.30 x 0.20] + [1.20 x 0.15] + [0.40 x 0.30]

= 0.315 + 0.260 + 0.180 + 0.120

= 0.875

Emma’s Portfolios Required Rate of Return

Ariel’s Portfolios Required Rate of Return = Risk-free Rate + (Beta x Market Risk Premium]

= 7.000% + [0.875 x 8.500%]

= 7.000% + 7.438%

= 14.438%