Question

1. You are creating a portfolio from the following companies: 1. MSFT à B = 1.13 2. PG à B = 0.59 3. NFLX à ß = 1.66 You will invest 50% into PG, 25% in NFLX, and 25% in MSFT. Considering this information, which of the following statements is accurate? portfolio beta is smaller than the beta of the risk-free asset portfolio beta is greater than that of the market beta portfolio beta is smaller than that of the market beta portfolio beta is larger than all of the individual asset betas

Answer 1

Given in the Question

Beta of MSFT = 1.13; Weightage of MSFT in portfolio = 25%

Beta of PG = 0.59; Weightage of PG in portfolio = 50%

Beta of NFLX = 1.66; Weightage of NFLX in portfolio = 25%

Let us understand some terms which are given in the question and the options:

Beta

Beta of a security is the measure of the volatility of its returns relative to the market. It is a measure of the risk related to that particular investment security. Higher the beta, higher is the risk and the return and vice-versa.

Beta of the Risk-Free Asset

Beta of a risk free asset is Zero.

Market Beta

Market beta is the beta of the market portfolio of all investable assets, and it is equal to 1.

Portfolio Beta

When individual asset betas and their weightage in a portfolio are given, the portfolio beta is calculated as given below:

Porfolio Beta = (Weightage in Portfolio of Asset A * Beta of Asset A) + (Weightage in Portfolio of Asset B * Beta of Asset B) + (Weightage in Portfolio of Asset C * Beta of Asset C)

= (Weightage of MSFT * Beta of MSFT) + (Weightage of PG * Beta of PG) + (Weightage of NFLX * Beta of NFLX)

Plugging the values of individual assets weightage and their betas from the question into the above formula:

Portfolio Beta = (1.13 *0.25) + (0.59 * 0.50) + (1.66 * 0.25) = 0.9925

So our portfolio Beta = 0.9925

Now checking the options:

Option 1

Beta of Risk Free Asset is Zero, and Portfolio beta is 0.9925, so first option is not correct

Option 2

Market beta is 1, so portfolio beta is not greater than the market beta

Option 3

Portfolio Beta (0.9925) is smaller than Market Beta (1)

Thus, Option 3 is correct

Option 4

Portfolio Beta is not greater than individual betas of all the assets

So, the correct option is Option 3..