The beta of a firm’s stock indicates the degree to which changes in stock price track changes in the stock market as a whole and is interpreted as the market risk of the portfolio. A beta of 1.0 indicates that, on average, the stock rises (or falls) the same percentage as does the market. A beta of 2.0 indicates a stock that rises or falls at twice the percentage of the market. The beta of a stock portfolio is the weighted average of the betas of the individual stock securities, weighted by the current market values (market value is share price times number of shares). Consider the following portfolio:
100 shares Speculative Computer at $35 per share, beta = 2.4
200 shares Conservative Industries at $88 per share, beta = 0.6
150 shares Dependable Conglomerate at $53 per share, beta = 1.2
a. Find the beta of this portfolio.
b. To decrease the risk of the portfolio, you have decided to sell all shares of Speculative Computer and use the money to buy as many shares of Dependable Conglomerate as you can.16 Describe the new portfolio, find its beta, and verify that the market risk has indeed decreased.