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	2.50
B	1.00
C	0.50
D	??????? ?1.50

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

a)Since there will be equal investments in all the assets. For calculating the Beta, we will assign equal weight to each asset i.e. 0.25

=0.25*Beta of A+0.25*Beta of B+0.25*Beta of C+0.25*Beta of D

=0.25*2.5+0.25*1+0.25*0.5+0.25*1.5

=1.375

Hence the Beta of the portfolio is 1.375

b) A 25% increase in the expected return will increase the return by: (Beta of the portfolio)*(Change in return of the market)

=1.375*25% = 34.375%

The return of the portfolio will increase by 34.375%

c) Similarly a 25% decrease in the expected return will decrease the return by: (Beta of the portfolio)*(Change in return of the market)

=1.375*(-25%) = -34.375%

The return of the portfolio will decrease by 34.375%

d) In order to decrease the overall Beta of the portfolio, I will decrease the allocation to Asset A and increase the allocation of investment to Asset C.

I will decrease the allocation to Asset A, because it is making the highest impact in the Portfolio Beta because of its high Beta. Similarly, the impact of Asset C is the highest in reducing the Portfolio's Beta. Hence if we increase the allocation to Asset C we will be able to have higher impact.