Risk Management: diversify by betas; can a portfolio be risk free?

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Please assist with the following:

1. If one of your stocks has a relatively high beta of 1.4 and is currently doing exceedingly well, why would you want a stock in your portfolio with a relatively low beta of 0.7 that has been recently under-performing? By diversifying your investments according to betas, have you entirely removed the potential risk of losses due to a declining stock market?

2. If you are relatively risk adverse, would you require a higher beta stock to induce you to invest than the beta required by a person more willing to take risks? Explain. From the investment instruments in the simulation, is it possible to construct a portfolio that is risk free? Explain.

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Solution Preview

1. If one of your stocks has a relatively high beta of 1.4 and is currently doing exceedingly well, why

would you want a stock in your portfolio with a relatively low beta of 0.7 that has been recently

under-performing? By diversifying your investments according to betas, have you entirely removed the

potential risk of losses due to a declining stock market?

First, let's take a look at the risk composition of the portfolios:

Total Risk = Systematic risk + non-Systematic risk

The Systematic risk is the risk intrinsic to the stock market, such as business cycle, ...

Solution Summary

The 374 word solution explains about risk and beta in response to the questions below.

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