BETA MANAGEMENT

Beta Management
Introduction:
Beta Management Company is a small investment management company. They had

approximately 25 million dollars when they started in 1991. Their company goal is to enhance returns but reduce risks for clients via market timing. Initially Betas funds were invested into the Vanguard 500, an S&P 500 no-load and low-expense index funds (with the remainder in money market instruments). The founder and CEO, Sarah Wolfe, adjusted the level of market exposure from 50-99% of the fund. She tried to time the market and reduce exposure to the market by decreasing the percent of the investment that was allocated to the Vanguard 500 index.

When the market was about to go on an upswing they would invest more heavily in the index funds. Betas performance was tied to Ms Wolfes ability to predict the market. By 1991, Ms Wolfe decided it was time to invest in individual stocks of smaller companies. Based on

recommendations from stock market analysts they recommended that she take a look at California REIT and Brown Group. She hired two analysts for that purpose. California R.E.I.Ts stock price closed at $ 21/4 per share and Brown Group, Inc.s price is $24. A $200,000 purchase of one of these stocks would increase her total equity exposure to $20 million. Still, she had some doubts but she promised her clients of reasonable returns.

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Q.1 Calculate the variability or Standard Deviation of the stock returns of California Reit and Brown group during past two years, how variable they are in comparison with the Vinegar 500 index trust fund?
month 1989jan 1989feb 1989mar 1989apr 1989may 1989jun 1989july 1989aug 1989sep 1989oct 1989nov 1989dec 1990jan 1990feb Vanguard trust Index 500 California REIT Brown Group

7.32%

-28.26%

9.16%

-2.47%

-3.03%

0.73%

2.26%

8.75%

-0.29%

5.18%

-1.47%

2.21%

4.04%

-1.49%

-1.08%

-0.59%

-9.09%

-0.65%

9.01%

10.67%

2.22%

1.86%

-9.38%

0.00%

-0.40%

10.34%

1.88%

-2.34%

-14.38%

-7.55%

2.04%

-14.81%

-12.84%

2.38%

-4.35%

-1.70%

-6.72%

-5.45%

-15.21%

1.27%

5.00%

7.61%

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1990mar 1990apr 1990may 1990jun 1990july 1990aug 1990sep 1990oct 1990nov 1990dec S.D 2.61% 9.52% 1.11%

-2.50%

-0.87%

-0.51%

9.69%

0.00%

12.71%

-0.69%

4.55%

3.32%

-0.32%

3.48%

3.17%

-9.03%

0.00%

-14.72%

-4.89%

-13.04%

-1.91%

-0.41%

0.00%

-12.50%

6.44%

1.50%

17.26%

2.72% 4.61%

-2.56% 9.23%

-8.53% 8.17%

The variability of both California REIT and Brown Group is double as compare to the Vanguard 500 Index Trust.

According to the calculation we have found the following information:

Stock Standard deviation

Vanguards Index 4.505138713%

California Reit 9.03638%

Brown Group 8.17%

After making the comparison we have found that the Stock California Reit is more risky than Brown Group because the standard deviation of that group is more than the brown group so

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the Brown Group will be much better for investment which is less risky based on the standard deviation. Question.2 The variability of the portfolio with r in asset one and 1-w in asset 2 is:

The covariance will help us in the determination of risk ness of the stock: The covariances are: Stock Covariance (Vanguards Index, Stock) Cal. Reit 0.0003 Brown Group 0.0024

Variability (Standard Deviation) of the portfolio (99%Vanguard, 1% Cal. REIT) = [(.99) (.0461) + 2(.99) (.01) (.0003) + (.01)(.0923)]1/2 = 4.57% The Variability (Standard Deviation) of the portfolio (99%Vanguard, 1% Brown Group) = [(.99) (.0461) + 2(.99) (.01) (.0024) + (.01) (.0817)] 1/2 = 4:61% Comparing these portfolios, we see that the Brown stock adds more variability to the Portfolio. Thus, Brown is riskier. This answer differs from that in part (a) because a large part of the portfolio's risk is related to the covariance between the individual stock and Vanguard. We variability of ach security has been measured which gives us more accurate result. Since the Covariance between Brown's stock and Vanguard is almost 8 times that between Cal.REIT and Vanguard, the portfolio that includes Brown is riskier.

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Question.3 How the expected return for each stock might relates to its riskiness? As we know the rule higher the risk higher the return, as in part 2 we have find Brown is more risky than California REIT thats why it will have high return on other hand the California has the less return because of less variability in the portfolio. Because investors wants to have a diversifiable portfolio thats why they want the result in portfolio context. Stock Cal. Reit Brown Group Beta 0.1474 1.6633

The Higher the Beta the Higher risk.

Capital Asset Pricing Model: (CAPM)

A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.

Assumed that risk free rate is 6% then:

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California

r = RF + (rm-rf) r=0.03+ (4.505139-0.03)0.1474 r=0.6896

Brown Group r= RF+ (rm-rf) r=0.03+(4.505139-0.03)1.6633 r=7.4735 The return of brown is greater than calfornia because the risk of the brown is greater.

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TABLE 1 Slope Months 1989 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1990 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec MEAN VARIANCE S.D Slope 0.1473 1 California X -28.26 -3.03 8.75 -1.47 -1.49 -9.09 10.67 -9.38 10.34 -14.38 -14.81 -4.35 -5.45 5 9.52 -0.87 0 4.55 3.48 0 -13.04 0 1.5 -2.56 -2.265416667 81.65621649 9.230735982 81.65622 X-e(X) -25.9946 -0.76458 11.01542 0.795417 0.775417 -6.82458 12.93542 -7.11458 12.60542 -12.1146 -12.5446 -2.08458 -3.18458 7.265417 11.78542 1.395417 2.265417 6.815417 5.745417 2.265417 -10.7746 2.265417 3.765417 -0.29458 [X-e(x)]^2 675.7184 0.584588 121.3394 0.632688 0.601271 46.57494 167.325 50.6173 158.8965 146.7631 157.3666 4.345488 10.14157 52.78628 138.896 1.947188 5.132113 46.4499 33.00981 5.132113 116.0916 5.132113 14.17836 0.086779

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TABLE 3 Brown Months 1989 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1990 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec MEAN VARIANCE S.D Slope [Type text] X 9.16 0.73 -0.29 2.21 -1.09 -0.65 2.22 0 1.88 -7.55 -12.84 -1.7 -15.21 7.61 1.11 -0.51 12.71 3.32 3.17 -14.72 -1.91 -12.5 17.26 -8.53 -0.67167 63.91749 8.166793 1.16 Page 8 63.91749 8.166793 X-e(X) 9.831667 1.401667 0.381667 2.881667 -0.41833 0.021667 2.891667 0.671667 2.551667 -6.87833 -12.1683 -1.02833 -14.5383 8.281667 1.781667 0.161667 13.38167 3.991667 3.841667 -14.0483 -1.23833 -11.8283 17.93167 -7.85833 [X-e(x)]^2 96.66167 1.964669 0.145669 8.304003 0.175003 0.000469 8.361736 0.451136 6.511003 47.31147 148.0683 1.057469 211.3631 68.586 3.174336 0.026136 179.069 15.9334 14.7584 197.3557 1.533469 139.9095 321.5447 61.7534

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