How to Calculate the Beta of a Perfect Portfolio
What is the beta of your perfect portfolio?
Given Stock Amount, Investment, and Beta:
A - $4 million, 1.8
B - $2 million, 1.6
C - $2 million, 1.4
D - $1 million, 0.8
E - $1 million, 0.4
Calculation of Beta for the Perfect Portfolio
The beta of the perfect portfolio can be calculated by weighting the betas of individual stocks based on the amount invested in each stock.
To calculate the beta of the perfect portfolio, multiply the beta of each stock by the respective amount invested, sum up these values, and divide by the total amount invested in the portfolio.
In this case, the weighted beta calculation would be: (4 million x 1.8 + 2 million x 1.6 + 2 million x 1.4 + 1 million x 0.8 + 1 million x 0.4) / (4 million + 2 million + 2 million + 1 million + 1 million).
The calculation results in a beta of 1.42 for the perfect portfolio. This beta represents the overall systematic risk of the portfolio, taking into account the weights and betas of the individual stocks.
A beta of 1.42 indicates that the perfect portfolio is expected to be 42% more volatile than the overall market.
Understanding Beta and Portfolio Management
Beta is a measure of a stock's volatility in relation to the overall market. A beta of 1 indicates that the stock's price will move in line with the market, while a beta greater than 1 signifies higher volatility and a beta less than 1 suggests lower volatility.
Portfolio management involves selecting the right mix of assets to achieve a balance between risk and return. By calculating the beta of a portfolio, investors can assess the level of systematic risk and make informed decisions about diversification.
When constructing a portfolio, it is essential to consider not only the individual characteristics of each stock but also how they interact with each other in terms of risk and return. Understanding beta and its impact on portfolio performance is crucial for successful investment management.