Question 1

Portfolio X consists of 4 stocks which are A, B, C, and D. The information pertaining to the stocks, the portfolio and the market are given below:

Stock Investment Beta

A $25,000 0.8

B $25,000 1.2

C $25,000 Not available

D $25,000 Not available

Portfolio X $100,000 1

Expected return of the market = 10%

Risk-free rate = 4%

(a) Calculate the beta of Portfolio Y that is equally invested in stock A and stock B.

(3 marks)

(b) Compute the beta of Portfolio Z that is equally invested in stock C and stock D.

(3 marks)

(c) Suppose you sell all $25,000 invested in Stock A and use the proceeds to invest in Stock B. Calculate the resulting value of the beta of Portfolio X.

(3 marks)

(d) Compute the change in the expected return of Portfolio X resulting from your actions in part (c).

(3 marks)

(e) Discuss the likely circumstances where you would sell a stock with a lower beta and invest the proceeds in a stock with a higher beta, as in part (c).

(3 marks)