Your portfolio is diversified. It has an expected return of 10.0% and a beta of
ID: 2660774 • Letter: Y
Question
Your portfolio is diversified. It has an expected return of 10.0% and a beta of 1.10. You want to add 500 shares of Tundra Corporation at $30 a share to your portfolio. Tundra has an expected return of 14.0% and a beta of 1.30. The total value of your current portfolio is $50,000.
a. Calculate the expected return on the portfolio after the purchase of the Tundra stock?
b. Calculate the expected beta on the portfolio after you add the new stock?
c. Is your portfolio less risky or more risky than average? Explain.
d. Will your portfolio likely outperform or underperform the market in a period when stocks are rapidly falling in value? Explain.
e. Is beta always an accurate predictor of a portfolio's performance? Explain?
Explanation / Answer
Portfolio = $50000
value of Tundra shares = $30*500 = 15000
New value of the portfolio = 65000
weigh of Tundra Stock = 15000/65000
weight of the rest of the portfolio = 50000/65000
expected return = 15000/65000*14 + 50000/65000*10 = 10.92%
expected beta = 15000/65000*1.3 + 50000/65000*1.1 = 1.15
Portfolio is more risky than the average as the systematic risk of the average market portfoilio measured by its beta equals 1, whereas the beta of this portfolio is 1.15.
The portfolio will underperform in the event when the prices are falling as it is positively correlated to the market movements by a factor of more than 1.
Beta is not always a good predictor of portfolio's performance, as the beta is calculated based on historical performance which might not be consistent with the future performance.
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