Question

Emma holds a $7,500 portfolio that consists of four stocks. Her investment in each stock, as well as each stock's beta, is listed in the following table: Stock Investment Beta Standard Deviation $2,625 0.80 12.00% 1.30 11.00% Omni Consumer Products Co. (OCP) Tobotics Inc. (TI) Water and Power Co. (WPC) Makissi Corp. (MC) $1,500 $1,125 $2,250 16.00% 1.10 0.40 0.40 19.50% Suppose all stocks in Emma's portfolio were equally weighted. Which of these stocks would contribute the least market risk to the portfolio? O Makissi Corp. O Tobotics Inc. O Water and Power Co. o Omni Consumer Products Co.

Answer 1

Market risk of a portfolio is determined by the beta of portfolio. Least market risk would be one with the lowest beta - Makissi Corp.

Total risk of a portfolio is determined by the standard deviation of portfolio. Least total risk would be one with the lowest standard deviation - Tobotics Inc

Beta of portfolio is weighted average of the beta of constituents.

Beta = (2625/7500) * 0.80 + (1500/7500) * 1.30 + (1125/7500) * 1.10 + (2250/7500) * 0.40

Beta = 0.35 * 0.80 + 0.20 * 1.30 + 0.15 * 1.10 + 0.30 * 0.40

Beta = 0.825

Required return (based on CAPM) = Risk free rate + Beta * Market Risk Premium

Required return (based on CAPM) = 4% + 0.825 * 6% = 8.95%