Question

In order to estimate IBM's beta you must have. historical returns on IBM's common historical returns on the risk-free rate historical returns on the market both (A) and (B) both (A) and (C).

The variance of returns on a portfolio of risky assets is a weighted sum of the variance of the individual assets. TRUE FALSE.

Answer 1

1. both (A) and (C) is correct

(A) historical returns on IBM's common

(B) historical returns on the market

Beta is the measure of movement /change /sensitivity in the assets in relation to the movement/change in the market. In other words, It is no. of times assets moves in relation to the market movement.

Beta can be calculated with following formula -

Return of risk-free assets is not related to Beta of a assets, we can see this in above equation. Thus, to estimate IBM's Beta we must have only historical return of IBM and historical return of Market.

2. FALSE

The variance of returns on portfolio of risky assets is not just a weighted sum of the variance of the individual assets because a diversified portfolio eliminates the unsystematic risk (a risk which is only related to the individual asset) of assets.

In other words, if correlation of risky assets in a portfolio is negative ( -1 > 0) then portfolio risk is less than the weighted sum of the variance of the individual assets and vice versa.

Correlation tells us, how two assets are related which means if one assets price is going up then where second assets price moving, if second assets also goes up means these assets are positively correlated and vice versa.

Variance of risky portfolio can be calculated with following formula -

With above formula we can say, variance of risk portfolio is not just weighted sum of individual stock's variance but also adjusted with correlation of assets.

Hope this will help, your feedback would be highly appreciated.