Question

5. Portfolio risk and return Aa Aa Ariel 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 Beta Standard Deviation Investment Perpetualcold Refrigeration Co. (PRC) $2,625 0.80 12.00% Zaxatti Enterprises (ZE) $1,500 1.30 11.50% Western Gas & Electric Co. (WGC) $1,125 1.15 16.00% Makissi Corp. (MC) $2,250 0.40 19.50% Suppose all stocks in Ariel's portfolio were equally Suppose all stocks in the portfolio were equally weighted. weighted. Which of these stocks would contribute the Which of these stocks would have the least amount of least market risk to the portfolio? standalone risk? Zaxatti Enterprises Perpetualcold Refrigeration Co. Makissi Corp. Makissi Corp. Perpetualcold Refrigeration Co. Western Gas & Electric Co. Zaxatti Enterprises Western Gas & Electric Co. If the risk-free rate is 4% and the market risk premium is 6%, what is Ariel's portfolio's beta and required return? Fill in the following ta ble: Required Return Beta Ariel's portfolio

Answer 1

Ans.5:

1). Stock with least market risk is the one with lowest beta which is Makissi Corp.

2). Stock with least standalone risk is the one with lowest standard deviation which is Zaxatti Enterprises.

3). Portfolio beta = sum of weighted betas

= (2,625/7,500)*0.8 + (1,500/7,500)*1.30 + (1,125/7,500)*1.15 + (2,250/7,500)*0.40 = 0.8325

4). Portfolio return = risk-free rate + (beta*market risk premium)

= 4% + (0.8325*6%) = 9.00%

Ans.6:

1). New portfolio beta after reallocation = (20%*1.5) + (15%*1.10) + (65%*0.3) = 0.66

Portfolio return = 4% + (0.66*5.5%) = 7.63%

Change in portfolio return = new return - old return = 8.50% - 7.63% = 0.87% (Ans.)

2). Expected return of 9.13% is more than the new required return of 7.63%, so the portfolio is overvalued.

3). The portfolio allocation to the new stock X would remain the same as for Atteric but it has higher beta than Atteric, so the portfolio beta will increase, meaning the portfolio risk would increase.