5. Jeanne Lewis is attempting to evaluate 2 possible portfolios consisting of th

Question

5. Jeanne Lewis is attempting to evaluate 2 possible portfolios consisting of the same 5 assets but held in different proportions. She is particularly interested in using beta to compare the risk of the portfolios and, in this regard, has gathered the following data: a. Calculate the betas for portfolios A and B. b. Compare the risk of each portfolio to the market as well as to each other. Which portfolio is more risky? Hint: the beta of a portfolio is the weighted average of the individual stock betas.

Explanation / Answer

a) Beta for Portfolio A = 10%*1.3+30%*0.7+10%*1.25+10%*1.1+40%*0.9

=0.94

Beta for Portfolio B = 30%*1.3+10%*0.7+20%*1.25+20%*1.1+20%*0.9

=1.11

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b) Portfilio B is more risky as its beta is higher than the beta of Portfolio B. Beta is a measure of a stock's volatility in relation to the market. By definition, the market has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the market. A stock that swings more than the market over time has a beta above 1.0. If a stock moves less than the market, the stock's beta is less than 1.0.

The portfolio with beta closest to 1 is less risky. hence, Portfilio A is less risky while portfolio B is more risky

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