Question

Julie wants to create a $5,000 portfolio. She also wants to invest as much as possible in a high risk stock with the hope of earning a high rate of return. However, she wants her portfolio to have no more risk than the overall market. Which one of the following portfolios is most apt to meet all of her objectives?
A) Invest the entire $5000 in stock with a beta of 1.0

B) Invest $2500 in stock with beta of 1.98 and $2500 in a stock with beta of 1.0

C) Invest $2500 in a risk free asset and $2500 in a stock with beta of 2.0

D) Invest $2500 in a stock with a beta of 1.0; $1250 in risk free asset, and $1250 in stock with beta of 2.0

E) Invest $2000 in a stock with beta of 3.0; $2000 in a risk free asset, and $1000 in a stock with a beta of 1.0

Answer 1

Answer:

C) Invest $2500 in a risk free asset and $2500 in a stock with beta of 2.0

Explanation:

Stock that is beta 2 means that it is twice as volatile as the whole market. Meaning for example if the market is expected to move by 5% this stock will move 10%. New startup firms that are fast-growing usually have stocks in this category. It is more risky thank normal shares but no too much. We can invest $2,500 here.

We invest the remaining $2,500 in risk-free assets

This is a backup on the chance that the investment on beta 2 stocks do not perform, the risk-free assets will make up for losses.