4. Portfolio risk and return Aa Aa Ariel holds a $5,000 portfolio that consists

Question

4. Portfolio risk and return Aa Aa Ariel holds a $5,000 portfolio that consists of four stocks. Her investment in each stock, as well as each stock's beta, is listed in the following table: Investment $1,750 $1,000 $750 $1,500 Beta 0.80 1.30 1.10 0.50 Standard Deviation 15.00% 11.00% 16.00% 19.50% Stock Perpetualcold Refrigeration Co. (PRC) Tobotics Inc. (TI) Three Waters Co. (TWC) Makissi Corp. (MC) Suppose all stocks in Ariel's portfolio were equally weighted. Which of these stocks would contribute the least market risk to the portfolio? Suppose all stocks in the portfolio were equally weighted Which of these stocks would have the least amount of standalone risk? O Makissi Corp O Perpetualcold Refrigeration Co O Tobotics Inc O Tobotics Inc. Three Waters Co. O Makissi Corp O Perpetualcold Refrigeration Co Three Waters 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 table Beta Required Return Ariel's portfolio

Explanation / Answer

Market risk is given by Beta. Therefore, Makissi Corp has the least market risk as it has the least beta.

Standalone risk is given by Standard Deviation. Therefore, Tobotics Inc has the least standalone risk as it has the least standard deviation.

Portfolio Beta

Weight of PRC = $1750 / $5000 = 0.35

Weight of TI = $1000 / $5000 = 0.20

Weight of TWC = $750 / $5000 = 0.15

Weight of MC = $1500 / $5000 = 0.30

Portfolio Beta = Beta of PRC x Weight of PRC + Beta of TI x Weight of TI + Beta of TWC x Weight of TWC + Beta of MC x Weight of MC

or, Portfolio Beta = 0.80 x 0.35 + 1.30 x 0.20 + 1.10 x 0.15 + 0.50 x 0.30 = 0.855 or 0.86

Portfolio's Required return

Required return = Risk free rate + Portfolio Beta x market risk premium = 4% + 0.855 x 6% = 9.13% or 9.1%

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