Question

1. Beta is a measure of volatility. Discuss how beta is utilized by the individual investor for decision making regarding one particular stock. Also, discuss how to utilize beta when examining one particular stock to fit within a portfolio of stocks. Apply your discussion to a company of your choosing.

2. Regarding the company you researched for the Beta discussion, what is the stock’s standard deviation and expected value? Explain what they are and how they apply to risk management and investment decision making

Answer 1

1. If the investor is a risk-averse investor, the he should invest in stocks that have lower beta. The market always has a beta of 1. If the investor wants risks lower than that of the market, he should invest in stocks with beta lower than 1. If the investor likes risk, then he should invest in stocks with beta greater than 1.

For example '"The Boeing Company" (BA) Stock has a beta of 1.63. I am a risk taking individual and hence I would invest in this particular stock. If on the other hand, there is a risk-averse investor, he/she should not invest in the stock of "The Boeing Company" since its beta is higher than 1.

2. We have selected "Boeing" in our beta discussion. So the Standard deviation for Boeing Stock is about 6.32%.

The expected return on Boeing = risk free return + Beta *(Market return - risk free return)

The risk free return is the T-bill rate which is considered as 3%, the stock market return (historical) is considered as 10%.

So the expected return on Boeing = 3 +1.63*(10-3) = 14.41%

So, as the risk (Beta) is higher than 1, the return of Boeing is expected to be higher than the market return of 10%. Hence the expected return of Boeing is 14.41%.

Conclusion: Higher risk results in higher return and investor shall make the decision based on his/her risk taking ability.