You have the following information on two securities in which you have invested:

Question

You have the following information on two securities in which you have invested:


Security Expected Return Standard Deviation Beta Percent Invested (w)
Xerox 15% 4.5% 1.20 35%
Kodak 12% 3.8% 0.98 65%

a. which stock is riskier in a portfolio context? Which stock is riskier if you are considering them as individual assets (not part of a portfolio)?
b. compute the expected return on the portfolio.
c. if the securities have a correlation of +0.60, compute the standard deviation of the portfolio.
d. compute the beta of the portfolio.

Explanation / Answer

a. From a portfolio risk perspective, Xerox would be considered the riskier stock because it has a larger beta (1.2) than Kodak (0.98). When considering each stock individually, a measure of total risk (adjusted for relative magnitudes of expected returns) is appropriate.

This measure would be the coefficient of variation. The coefficient of variation for Xerox is 0.30 (4.5%/15%). The coefficient of variation for Kodak is 0.32 (3.8%/12%), indicating that Kodak is the riskier of the two securities.

b. E(R) = .35(15%) + .65(12%) = 13.05%

c. p = [(.35)2(4.5%)2 + (.65)2(3.8%)2 + 2(.35)(.65)(.6)(4.5%)(3.8%)].5

= 3.64%

d. p = .35(1.2) + .65(.98) = 1.06

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