Professional Documents
Culture Documents
Practice Questions Risk and Returns
Practice Questions Risk and Returns
8.2 An individual has $20,000 invested in a stock with a beta of 0.6 and another $75,000
invested in a stock with a beta of 2.5. If these are the only two investments in her portfolio,
what is her portfolio’s beta?
Investment Beta
$20,000 0.6
75,000 2.5
Total $95,000
N
r^ =∑ P i r i
i=1 .
√
N
∑ (ri −r^ )2 Pi
b. = i=1 .
If Stock B is less highly correlated with the market than A, then it might have a
lower beta than Stock A, and hence be less risky in a portfolio sense.
8.7
Alternative solution: First, calculate the return for each stock using the CAPM
equation
[rRF + (rM – rRF)b], and then calculate the weighted average of these returns.
8.14 Suppose you held a diversified portfolio consisting of a $7,500 investment in each of 20
different common stocks. The portfolio’s beta is 1.25. Now suppose you decided to sell one
of the stocks in your portfolio with a beta of 1.0 for $7,500 and use the proceeds to buy
another stock with a beta of 0.80. What would your portfolio’s new beta be?
$142,500 $7,500
Old portfolio beta= $150,000 (b) + $150,000 (1.00)
1.25 = 0.95b + 0.05
1.20 = 0.95b
1.263158 = b.
New portfolio beta = 0.95(1.263158) + 0.05(0.80) = 1.24.
Alternative solutions:
1. Old portfolio beta = 1.25 = (0.05)b1 + (0.05)b2 + ... + (0.05)b20
1.25 = (∑ bi ) (0.05)
∑ bi = 1.25/0.05 = 25.
New portfolio beta = (25.0 – 1.0 + 0.80)(0.05) = 1.24.
∑ bi
2. excluding the stock with the beta equal to 1.0 is 25.0 – 1.0 = 24, so the beta
of the portfolio excluding this stock is b = 24.0/19 = 1.263158. The beta of the
new portfolio is:
1.263158(0.95) + 0.80(0.05) = 1.24.
8.17 PORTFOLIO BETA A mutual fund manager has a $20 million portfolio with a beta of
1.7. The risk-free rate is 4.5%, and the market risk premium is 7%. The manager expects to
receive an additional $5 million, which she plans to invest in a number of stocks. After
investing the additional funds, she wants the fund’s required return to be 15%. What should
be the average beta of the new stocks added to the portfolio?
After additional investments are made, for the entire fund to have an expected return of 15%,
the portfolio must have a beta of 1.50 as shown below:
15% = 4.5% + (7%)b
b = 1.50.
Since the fund’s beta is a weighted average of the betas of all the individual
investments, we can calculate the required beta on the additional investment as follows:
($ 20 ,000 ,000)(1.7) $5 ,000 ,000 X
1.50 = $25 ,000 ,000 + $ 25,000,000
1.50 = 1.36 + 0.2X
0.14 = 0.2X
X = 0.70.