1. Case: Beta Management Week 6

2. The Objectives 1. To gain practice in calculating risk and return measures on stocks and portfolios, including estimation of beta for stocks by simple regressions. 2. To understand concepts of total risk, portfolio risk, diversifiable and undiversifiable risk, and how these relate to the beta. 3. To gain an appreciation of the relation between risk and return, and the CAPM. 4. To allow an introductory discussion of investment strategies.

3. The Issues 1. The Strategy 2. The Choices 3. The Risks 4. The Return

4. The Strategy How should we describe Ms. Wolfe’s portfolio management strategy? Where is she adding “value”? Why do you think she is following her existing strategy? Why is she changing?

5. The Choices What is her goal in investing in the stocks she’s considering? Why these stocks?

6. The Risks 1. The total risk: the standard deviation of each stock/fund. Vanguard =15.96%, REIT = 32%, Brown=28.30%. 2. The portfolio risk: 99% Vanguard + 1% Stock. REIT= 15.82%Brown= 15.98%. 3. The beta (the risk that is not diversifiable): REIT=0.147(t statistic=0.34). Brown=1.16 (t statistic=4.08). What is the relevant risk?

7. What Is the Economic Significance? Consider the dollar impact on existing portfolio when the new asset is added. Current investment = $19.8 M in index fund of volatility, with volatility of 15.96%. In terms of dollars, the volatility is 0.1596*19.8 = $3.16 M. If additional $200 K is invested in Brown, the new dollar volatility is 0.1598x20=$3.196M, and dollars at risk increase by $36,000 (3,196,000-3,160,000). If additional $200 K is invested in the California REIT, the dollars at risk decrease by $400. If additional $200 K is invested in index itself, the dollars at risk increase by $31,920. Approximate beta of California REIT = 400/31,920=0.125(From regression, beta = 0.147). Approximate beta of Brown = 36,000/31,920=1.13 (From regression, beta = 1.16).

8. The (Required) Returns 1. What expected return is sufficient to induce you to invest in either stock?

9. Some Information of REITS (NAREIT, http://www.nareit.com)http://www.nareit.com REIT: Real Estate Investment Trust. A REIT invests in income-producing property, and may also invest in loans on property. There are about 300 REITs, with about 2/3 traded on an exchange, and with assets over $300 B. Cumulative returns from 1/1/99 to 3/3/2003: –REIT=40.67%, S&P500 = -32.09%. Volatility over 1/1/99 to 3/3/2003. –REIT = 11.71%, S&P = 22.16%. Correlation between returns over 1/1/99 to 3/3/200: 0.2843. REIT Index beta from daily data = 0.15.