Question

Portfolio Beta Problem THIS ALL THE INFORMATION THAT I HAVE.

Please answer the following questions related to a Portfolio of stocks consisting of the stocks of the Dow 30 (assume an equal investment in each stock - perhaps $1000 investment for each).

1.) Calculate the beta of this portfolio of stocks using the current betas for each stock as given on Yahoo Finance or CNBC.  What does this portfolio beta measure?

2.) What should the owner of this portfolio expect in regards to unsystematic risk?

3.) What should the owner of this portfolio expect in regards to systematic risk?

4.)  Based on your calculation for the Portfolio Beta for this Portfolio, what should the owner expect in the way of return compared to the return of the S&P 500?

5.)  Based on the composition of the Portfolio, what can you say about the owner's risk tolerance?

Your answers should be supported by examples, quotes from the text, quotes from other sources, calculations, or whatever you see as appropriate to describe your position.  Your answers should reflect proper grammar, good spelling, complete sentences, and proper paragraph structure.  I would expect to receive approximately 2-3 pages

Answer 1

Dow Jones Industrial Average
Symbol	Company Name	Beta	Portfolio weight	Portfolio weight * Beta
KO	The Coca-Cola Company	0.41	0.03	0.01
MCD	McDonald's Corporation	0.40	0.03	0.01
DIS	The Walt Disney Company	0.52	0.03	0.02
PFE	Pfizer Inc.	0.52	0.03	0.02
CSCO	Cisco Systems, Inc.	1.00	0.03	0.03
VZ	Verizon Communications Inc.	0.50	0.03	0.02
WMT	Walmart Inc.	0.64	0.03	0.02
V	Visa Inc.	0.83	0.03	0.03
AAPL	Apple Inc.	0.99	0.03	0.03
PG	The Procter & Gamble Company	0.23	0.03	0.01
UTX	United Technologies Corporation	1.17	0.03	0.04
NKE	NIKE, Inc.	0.85	0.03	0.03
HD	The Home Depot, Inc.	1.24	0.03	0.04
TRV	The Travelers Companies, Inc.	0.99	0.03	0.03
AXP	American Express Company	1.08	0.03	0.04
CVX	Chevron Corporation	0.01	0.03	0.00
IBM	International Business Machines Corporation	1.73	0.03	0.06
WBA	Walgreens Boots Alliance, Inc.	0.83	0.03	0.03
MSFT	Microsoft Corporation	1.03	0.03	0.03
JNJ	Johnson & Johnson	0.65	0.03	0.02
GS	The Goldman Sachs Group, Inc.	1.20	0.03	0.04
BA	The Boeing Company	1.33	0.03	0.04
JPM	JPMorgan Chase & Co.	1.07	0.03	0.04
XOM	Exxon Mobil Corporation	0.98	0.03	0.03
MRK	Merck & Co., Inc.	0.38	0.03	0.01
UNH	UnitedHealth Group Incorporated	1.06	0.03	0.04
INTC	Intel Corporation	0.52	0.03	0.02
DWDP	DowDuPont Inc.	1.05	0.03	0.04
MMM	3M Company	1.15	0.03	0.04
CAT	Caterpillar Inc.	1.38	0.03	0.05
			Total	0.858
Portfolio Beta=	0.858

Note- this could have also calculated by taking simple average of the individual beta of the 30 stocks since this is an equally weighted portfolio.

Portfolio beta is the measure of volatility or systematic risk of the portfolio. Note that the beta is always calculated in comparison to or with respect to the benchmark or broader market.

2. the portfolio of 30 stocks from Dow index is a fairly diversified portfolio. All the constituents are large or mega cap companies and individual weight of any security is less than 3.5% as it is equally weighted. Hence, the portfolio is not expected to have any unsystematic risk. Point here to understand is that the unsystematic risk arises from a company specific events. In the given portfolio, the impact of any single company specific change is fairly low.

3. the portfolio has systemic risk. The beta of portfolio is less than 1 (0.85). Hence, the systemic risk of the portfolio is lower than the market- 85.8% of the market systemic risk to be precise. However, this is a statistical relationship. The beta is calculated over last 3 years as per Yahoo Finance database. If a catastrophic event or crisis hits the market, the relationship or correlation between the stocks and the market may change and the beta might change as well. However, at this stage, the systemic risk or the market risk for the portfolio is lower.

4. the beta of the individual stocks has been calculated in relation to the broader market for which, the S&P500 index is the proxy. The beta for S&P500 is 1. A beta of 1 indicates full systemic risk. The portfolio has a beta of 0.86. This means that when the S&P500 index gives 10% return, the portfolio return will be 8.58% in perfect market conditions. The positive returns for the portfolio will be lower than the S&P500 but at the same time, the negative returns will be lower as well. Hence, the portfolio is expected to perform better than the S&P500 in down markets but worse than the S&P500 in up markets.

5. the owner’s risk tolerance appears to be low. He has refrained from taking any unsystematic risk. At the same time, the systemic risk taken by him is also lower than the market. Since no further information is provided, we can also call this as a naïve diversification. Usually, people who are not well trained in portfolio finance but have risk averse, cautious approach tend to follow this portfolio allocation as per behavioral finance. This again supports the proposition of low risk tolerance of the owner.