Question

You are considering the construction of a portfolio comprised of equal investments in each of four different stocks. The betas for each stock are found below:

Asset |
Beta |
||

A |
2.00 |
||

B |
1.05 |
||

C |
0.55 |
||

D |
−1.70 |

a. What is the portfolio beta for your proposed investment portfolio?

b. How would a 25 percent increase in the expected return on the market impact the expected return of your portfolio?

c. How would a 25 percent decrease in the expected return on the market impact the expected return on each asset?

d. If you are interested in decreasing the beta of your portfolio by changing your portfolio allocation in two stocks, which stock would you decrease and which would you increase? Why?

Answer #1

Portfolio beta is equal to weighted average beta

= 2*1/4 + 1.05*1/4 + 0.55*1/4 -1.70*1/4

= 0.475

b.Expected return on portfolio will increase by Portfolio Beta*% increase in market return

= 0.475*25%

= 11.875%

c. Return on Asset A will decrease by 2*25% = 50%

Return on Asset B will decrease by 1.05*25% = 26.25%

Return on Asset C will decrease by 0.55*25% = 13.75%

Return on Asset A will INCREASE by 1.7*25% = 42.50%

Portfolio return will decrease by 11.875%

d. Stock A would be decreased as it has highest beta

and Stock D would be would be increased as it has the lowest beta

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