You are the pension fund manager for a major university with $100 million in an index fund that invests in the S&P 500 stocks. Due to recent pressure from student groups, the regents have decided to divest themselves of the stocks of firms that invest in ABC Company. You estimate that this will eliminate 100 of the 500 stocks in your portfolio. You have been asked to evaluate the effect of the divestiture decision. You estimate that the correlation between acceptable and eliminated stocks is 0.6. You also have the following data:

acceptable stocks eliminated stocks

number of firms 400 100

total market value $3 billion $2 billion

average beta 1.0 1.25

standard deviation 25% 30%

1. What will the effect of the divestment be on the beta of your portfolio?

a. Portfolio b increases from 1 to 1.08

b. Portfolio b decreases from 1 to .92

c. Portfolio b increases from 1 to 1.31

d. Portfolio b decreases from 1 to .69

e. Portfolio b does not change.

2. How will divestment affect the standard deviation of your portfolio?

a. Portfolio s increases from 25% to 26.6%

b. Portfolio s decreases from 25% to 23.4%

c. Portfolio s increases from 25% to 27.5%

d. Portfolio s decreases from 25% to 20.5%

e. Portfolio s does not change.

3. Assume that the standard deviation of the overall market is 20%. What is the effect of divestment on the proportion of your portfolio's unsystematic risk remaining?

a. It rises by about 3% to about 23%.

b. It declines by about 3% to about 17%.

c. It rises by about 5% to about 28%.

d. It declines by about 3% to about 22%.

e. It rises by about 3% to about 28%.