Question

Q1：Assume that your portfolio has three stocks. You have $300,000 invested in stock A that is returning 17%, $300, 000 invested in stock B that is returning 16%, and $400,000 invested in stock C that is returning 18%. What is the expected return of your portfolio?

Q2: A beta coefficient for a stock of 0.8 implies

A. the stock is more risky than the market because an 1% decrease in the stock return

will cause the market return to decrease by 0.8%

B. the stock is more risky than the market because an 1% decrease on the market return will cause the return on this stock to decrease by 0.8%

C. the stock is less risky than the market because an 1% decrease in the stock return will cause the market return to decrease by 0.8%

D. the stock is less risky than the market because an 1% decrease in the market return

will cause the return on this stock to decrease by 0.8%

Answer 1

Answer 1 :

Investment in Stock A= 300,000, Stock B= 300,000, Stock C= 400,000

So, total value of portfolio= 300,000+ 300,000+ 400,000 = 1,000,000

so, weight of Stock A in portfolio= 300,000/1,000,000= 0.30

weight of Stock b in portfolio= 300,000/1,000,000= 0.30

weight of Stock c in portfolio= 400,000/1,000,000= 0.40

Thus, expected return of portfolio= (weight of Stock A* Return of stock A) + (weight of Stock B* Return of stock B) + (weight of Stock C* Return of stock C)

= (0.30*0.17) + (0.30*0.16) + (0.40*0.18)

= 0.051+ 0.048+ 0.0720

= 0.1710

=17.10%

Answer 2 : A beta coefficient for a stock of 0.8 implies (D) i.e.

the stock is less risky than the market because an 1% decrease in the market return will cause the return on this stock to decrease by 0.8%

Because Beta coefficient = Covariance of stock's return with the market return/ variance of the market return

i.e. if market return increases by 1 unit, the stock's return also changes by 1 unit and Beta=1 and vice versa for decrease in market return by 1 unit, the stock return will decrease by 1 unit and Beta=1

So, here in this case, if market return decreases by 1%, the stock return decreases by 0.8% so Beta= -0.8%/ -1%

= 0.8%

so beta =0.8%

So, option D is correct.