1. You have a $30,000 portfolio that consists of equal dollar investments in stocks A, B,...

1. You have a $30,000 portfolio that consists of equal dollar investments in stocks A, B, and C, each with a current price of $25. After one year, stock A is worth $40, stock B is worth $30, and stock C is worth $12.50. You wish to rebalance the portfolio to maintain equal dollar investments in each stock. How many shares of each stock do you buy and/or sell to rebalance the portfolio? A common behavioral hypothesis is that investors sell winners too soon and hold losers too long. Are your rebalancing actions consistent with this hypothesis?

Expert Solution

Investment in stock A = $ 30000/3 = $10000

No of shares A bought = $10000/25 = 400

Value of stock A after 1 year = $40*400=$ 16000

Investment in stock B = $ 30000/3 = $10000

No of shares B bought = $10000/25 = 400

Value of stock B after 1 year = $30*400=$ 12000

Investment in stock C = $ 30000/3 = $10000

No of shares C bought = $10000/25 = 400

Value of stock C after 1 year = $12.5*400=$ 5000

Rebalancing of portfolio means the value of the stocks become equal again (= initial scenario). So total value of all stocks = 16000+12000+5000=33000 or 11000 in each stock

So stock A total value needs to be $11000 or $16000-5000 or 5000 less, which means I need to sell $5000/40=125 shares of A

So stock B total value needs to be $11000 or $12000-1000 or 1000 less, which means I need to sell $1000/30=33.33 shares of B

So stock C total value needs to be $11000 or $5000+6000 or 6000 more, which means I need to buy $6000/12.5=480 shares of C

This is in line with the hypothesis of selling winners too soon (A and B) and buying loosers (C)

jeff jeffy answered 1 year ago

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