Revision - Practice 1

Stock Beta Specific risk Weight

X 1.2 30 0.5
Y 0.9 25 0.3
Z 1.6 45 0.2

The Treasury bill (T-Bill) interest rate is 10%, the market risk premium offers 12% and the standard
deviation of the market return is 24%.

1. Calculate the portfolio beta

2. Compute the expected return on the portfolio

3. Find the market risk of the portfolio

4. Determine the specific risk of the portfolio

5. Compute the total risk of the portfolio

Practice 1 (Solution)

Stock Beta Specific risk Weight

X 1.2 30 0.5
Y 0.9 25 0.3
Z 1.6 45 0.2

The Treasury bill (T-Bill) interest rate is 10%, the market risk premium offers 12% and the standard
deviation of the market return is 24%.

1. Calculate he portfolio beta

The weighted average of the betas of the component shares gives the beta of the portfolio;
𝛽𝑝 = ∑ 𝑊𝑖 𝛽𝑖
𝑖

i 𝑤𝑖 𝛽𝑖 𝑤𝑖 𝛽𝑖
X 0.5 1.2 0.60
Y 0.3 0.9 0.27
Z 0.2 1.6 0.32
beta(p) = 1.19

2. Compute the expected return on the portfolio

𝐸(𝑅𝑝 ) = 𝑅𝐹 + 𝛽𝑝 (𝐸(𝑅𝑚 ) − 𝑅𝑓 ) = 0.10 + 1.19(0.12) = 0.2428 or 24.28%

3. Find the market risk of the portfolio

The standard deviation of return on the market portfolio (𝜎𝑚 ) is given by 24%. The
market related risk on this portfolio is therefore
𝛽𝑝 𝜎𝑚 = 1.19 x 0.24 = 0.2856 or 28.56%
If the standard deviation is 0.2856, the variance is 0.0816.

4. Determine the specific risk of the portfolio

The variance of the specific risk of a portfolio is ∑(𝑤𝑖 𝜎𝜀𝑖 )2 where 𝜎𝜀𝑖 is the specific
risk of the component shares.

i 𝑤𝑖 𝜎𝜀𝑖 𝑤𝑖 𝜎𝜀𝑖 (𝑤𝑖 𝜎𝜀𝑖 )2

X 0.5 30 0.15 0.0225
Y 0.3 25 0.075 0.0056
Z 0.2 45 0.09 0.0081
2
𝜎𝜖𝑝 0.0362
 Standard deviation 𝜎𝜀𝑝 = 0.1903 or 19.03%

5. Compute the total risk of the portfolio

Total variance = market related variance + specific variance = 0.0816 + 0.0362 =

0.1178
Total standard deviation is √0.1178 = 0.3432 or 34.32%