Flirting with Risk

When Mary Owens Husband, Ralph, passed away about three months ago he left behind a small fortune, which he had accumulated by living a very thrifty life and by investing in common stocks. Ralph had worked as an engineer for a surgical instruments manufacturer for over 30 years and had taken full advantages of companys voluntary retirement savings plan. However, instead of buying a diversified of investment he had invested his money into a few high growth companies. Over time his investment portfolio had grown to about $900,000 being primarily comprised of the stocks of 3 companies. He was very fortunate that his selections turned out to be good ones and after numerous stocks splits the prices of the three companies had appreciated significantly over time.

Mary, on the other hand, was a very conservative and cautious person. She had devoted her life to being a stay home and had raised their two kids into adults, each of whom had a fairly successful career. Jim, 28, had followed in Ralphs footsteps. In addition to being gainfully employed as an engineer, he was pursuing an MBS at a prestigious business school. Annette, 26 was completing her residency at a major metropolitan hospital. Although Mary and Ralph had enjoyed a wonderful married life, it was Ralph who managed almost all the financial affair of their family. Mary, like many spouses of their generation, preferred to focus on other family matters.

It was only after Ralphs passing on that Mary realized how unprepared she was for the complex decisions that have to be made when managing ones wealth. Upon the advice of her close friend, Agnes, Mary decided to call the Brokers office and request that her account be turned over to Bill May, the firms senior financial advisor. Agnes, a widow herself, had been very happy with Bills advice and professionalism. He had helped her rebalance and re allocate her portfolio with the result that her portfolios value had steadily increased over the year without much volatility.

At their first meeting, Bill examined the owners portfolio ad was shocked at how narrowly focused its composition had been. In fact, just during the past year due to the significant drop in the technology sector the portfolio had lost almost 30% of its value. Ralph, certainly liked to flirt with risk, said Bill. The first thing we are going to have to do is diversified your portfolio and lower its beta. As it stands you could make a lot of money if the technology sector takes off, but the reverse scenario could be devastating. I am sure you will agree with me that given your status I life you do not need to bear this much/ of risk. Mary shrugged her shoulders and looked blankly at Bill. DiversifyBeta... what are you talking about? These terms are new to me and so confusing. You are right. Bill, I dont need the high risk but can you explain to me how the risk level of my portfolio can be lowered? Bill realized right away that Mary needed premier on the risk return tradeoff and on portfolio management. According, he schedule another appointment for later that week and prepared the following exhibit to demonstrate the various nuances of risk, expected return, and portfolio management.

Expected Rate of Return
Scenario	Probability	Treasury Bill	Index Fund	Utility Company	High tech company	Counter cyclical company
Recession	20%	5%	-10%	6%	-25%	20%
Near Recession	20%	5	-6%	7%	-20%	16%
Normal	30%	5	12%	9%	15%	12%
Near Boom	10%	5	15%	11%	25%	-9%
Boom	20%	5	20%	14%	35%	-20%

Required:

Mary has no idea what beta means and how it is related to the required return of the stocks. Explain how you would help her understand these concepts.

DON'T ANSWER IF YOU DONT KNOW WHAT TO DO, LOOKING FOR A DETAILED ANSWER, NOT SOME DUMB SHIT. READ WHAT IS REQUIRED. THANK YOU