You own a portfolio which is invested equally in two stocks and a risk-free security. Beta is .89 for Stock A and 1.26 for Stock B. Which one of the following will increase the portfolio beta, all else being constant?
A)increasing the amount invested in the risk-free security
B)decreasing the weight of Stock B and increasing the weight of Stock A
C)replacing Stock A with a security that has a beta of .77
D)increasing the weight of Stock A and decreasing the weight of the risk-free security
E)replacing Stock B with Stock C, which has a beta equal to that of the market

Question

Quizplus · Accepted Answer

The portfolio beta will increase if the weight of the higher beta stock (Stock B) and/or the weight of the risky assets in the portfolio is increased. Therefore, increasing the weight of Stock A and decreasing the weight of the risk-free security (choice D) will increase the portfolio beta. Choice A will decrease the portfolio beta as the risk-free security has a beta of zero. Choice C will decrease the portfolio beta as the replacement security has a lower beta than Stock A. Choice B may or may not increase the portfolio beta depending on the specific weights assigned to each stock. Choice E will have no effect on the portfolio beta as the beta of Stock C is equal to the market beta, which is the same as the current portfolio beta.

You Own a Portfolio Which Is Invested Equally in Two