Beta Investing Finance Term Paper

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Finance

My portfolio was constructed out of six stocks that are all market leaders. I was looking at mutual funds but could not find beta information so I went with all stocks. Each stock has a beta, which reflects the risk that company has, specifically how the stock moves in line with the market. This is not a causal relationship, just corollary -- the asset does not "react" to the market, it moves in line with investor expectations about its future, and the beta simply measures how those moves correspond with moves in the broad market.

In this paper, I outline the portfolio, along with the individual betas for each security, and the weighting of each asset in the portfolio. One of the important steps in portfolio management is the calculation of the portfolio beta. This is simply the weighted-average of the individual betas within the portfolio. A chart is provided to show how the total portfolio beta is 0.939, which is lower than the market beta of 1.0. This means that the portfolio is less volatile than the overall market. When the market declines, this portfolio should decline less. When the market increases, this portfolio should increase less. That is how beta is used to predict the behavior of assets on the market.

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There is also discussion in this paper about what it means to have a bearish or bullish outlook -- these are not really related to beta, which is by definition a rational investing tool while "bear" and "bull" are emotional sentiments that detract from investor rationality. Further, the fallacy of the beta reacting to the market movements is explained, noting that there is no causal relationship between the markets and individual securities.

My portfolio consists of six stocks, all market leaders. These blue chip stocks are Apple (20%), Google (20%), Exxon Mobil (20%), Wal-Mart (20%), Starbucks (10%) and Goldman Sachs (10%). The portfolio components, with their betas and total portfolio beta follows.

My Portfolio

Security

Beta

Weight

Apple

20

1.01

0.202

Google

20

1.15

0.23

Starbucks

10

1.18

0.118

Exxon Mobil

20

0.73

0.146

Goldman Sachs

10

1.69

0.169

Wal-Mart

20

0.37

0.074

0.939

The total portfolio beta is a weighted-average of the betas of the individual securities in the portfolio. So the weight for Apple is:

(.2)*(1.01) = 0.202

The same calculation is completed for all of the components….....

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