a) Richard holds a stock portfolio of RM1300,000 consisting of
RM30,000 invested in
each of 10 stocks. Each stock has a
beta of 0.9. Therefore, the portfolio beta will
be 0.9 and it will be less risky
than the market. Now suppose that Richard:
i) sells one of the existing stocks, and replaces it
with a stock with a beta of 2.0. What will
happen to the risk of the portfolio?
ii) sells one of the
existing stocks and replaces it with a stock with a beta of 0.6.
Calculate
the beta of the portfolio.
b) Stock Boxy has a beta of 1.8. An investor who is interested
in buying this stock expects its
return to be 18%. The current rate of
return from government securities provides an
average return of 6% and the expected
market risk premium is 10%. Is the investor
pessimistic or optimistic about stock
Boxy’s expected return relative to the market’s
expectation?
Answer a.
Weight of Stock = 1 / Number of Stocks
Weight of Stock = 1 / 10
Weight of Stock = 0.10
Part 1:
New Portfolio Beta = Old Portfolio Beta + Weight of New Stock *
Beta of New Stock - Weight of Old Stock * Beta of Old Stock
New Portfolio Beta = 0.90 + 0.10 * 2.00 - 0.10 * 0.90
New Portfolio Beta = 1.01
Part 2:
New Portfolio Beta = Old Portfolio Beta + Weight of New Stock *
Beta of New Stock - Weight of Old Stock * Beta of Old Stock
New Portfolio Beta = 0.90 + 0.10 * 0.60 - 0.10 * 0.90
New Portfolio Beta = 0.87
Answer b.
Required Return of Investor = 18.00%
Expected Return of Stock = Risk-free Rate + Beta * Market Risk
Premium
Expected Return of Stock = 6.00% + 1.80 * 10.00%
Expected Return of Stock = 24.00%
Investor is expecting less than market’s expectation; therefore, investor is pessimistic.
Get Answers For Free
Most questions answered within 1 hours.