Portfolio Risk

1
Portfolio Risk

• In general, the riskiness of a portfolio
  (?portfolio) will -
• Systematic vs. Diversifiable Risk

2
Beta

• Beta Defined -
• Examples
• Beta 1.0
• Beta 0.5
• Beta 2.0
• Beta lt 0.0

3
Calculating Beta

• Plot the stocks return over time against the
  markets return over time. Fit a (regression)
  line to the observations. The slope of the line
  is the firms estimated beta coefficient.
• Example 1 Given the following information,
  calculate the firms beta coefficient.
• Year Market Return Stock Return
• 1 8.4 10.1
• 2 10.2 12.7
• 3 2.3 6.5
• 4 15.6 22.1
• 5 -7.9 -9.3
• Estimated OLS Regression Line
• Correlation Coefficient

4
Calculating Beta, cont.

• Plot the stocks return over time against the
  markets return over time. Fit a (regression)
  line to the observations. The slope of the line
  is the firms estimated beta coefficient.
• Example 2 Given the following information,
  calculate the firms beta coefficient.
• Year Market Return Stock Return
• 1 6.6 5.9
• 2 -2.3 4.6
• 3 -14.5 3.6
• 4 7.1 4.8
• 5 15.9 6.8
• 6 18.3 8.8
• Estimated OLS Regression Line
• Correlation Coefficient

5
Portfolio Betas

• The Beta of a portfolio is -
• Example Calculate the beta of the following 3
  asset portfolio
• Stock Beta Portfolio Weighting
• Fair Isaac Co. 1.50 20
• Golden Books, Inc. 2.75 30
• General Motors 0.90 50

6
Integrating Risk Return

• Required Return Risk-Free Return Premium for
  Risk
• Security Market Line (SML) -
• Required Return on Stock I

7
SML Examples

• Ex. 1 Suppose Galoob Toys, Inc. has a beta of
  2.0 (i.e. its returns are twice as volatile, and
  tend to move in the same direction as, market
  returns). If the risk free rate of interest in
  the economy is 5, and the risk-premium available
  on an average (Beta 1.0) security is 3.5, what
  is the required rate of return on Galoob stock?
• Ex. 2 Suppose the required rate of return on
  the market portfolio was 11, the risk-free rate
  was 4, and you were considering investing in
  Penske Motorsports which has a beta of 1.85.
  What is your required rate of return on Penske
  Motorsports stock?

8
Implementing the SML

• Graphing the SML
• Complications
• Inflation -
• Risk Aversion -
• Changing Betas -

9
Investment Decisions the SML

• Decision Rules
• If
• If
• If
• Greater (Bigger) Fool Theory -