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 Beta’s 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.   Beta’s performance was tied to Ms Wolfe’s 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.T’s
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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 Vanguard Index 500 California Brown
month trust REIT Group

1989-
jan 7.32% -28.26% 9.16%
BETA MANAGEMENT
1989-
Q.1 Calculate the variability
feb -2.47% -3.03% 0.73%
or Standard Deviation of the
1989-
stock returns of California
mar 2.26% 8.75% -0.29%
Reit and Brown group during
1989- past two years, how variable
apr 5.18% -1.47% 2.21%
they are in comparison with
1989- the Vinegar 500 index trust
may 4.04% -1.49% -1.08%
fund?
1989-
jun -0.59% -9.09% -0.65%

1989-
july 9.01% 10.67% 2.22%

1989-
The variability of both California
aug 1.86% -9.38% 0.00% REIT and Brown Group is double
as compare to the Vanguard
1989-
500 Index Trust.
sep -0.40% 10.34% 1.88%

1989- According to the calculation

oct -2.34% -14.38% -7.55% we have found the following
1989- information:
nov 2.04% -14.81% -12.84%

1989-
dec
Stock 2.38% -4.35%
Vanguards Index -1.70%
California Reit Brown Group
Standard deviation
1990- 4.505138713% 9.03638% 8.17%
jan -6.72% -5.45% -15.21%

1990-
feb 1.27% 5.00% 7.61%
After making the comparison
1990- we have found that the Stock
mar 2.61% 9.52% 1.11%
California Reit is more risky
1990- than Brown Group because
apr -2.50% -0.87% -0.51% the standard deviation of
1990- that group is more than the
may 9.69% 0.00% 12.71% brown group so the Brown
1990- Group will be much better for
jun -0.69% 4.55% 3.32% investment which is less risky
1990- based on the standard
july -0.32% 3.48% 3.17% deviation.
1990-
Question.2
aug -9.03% 0.00% -14.72%

1990-
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sep -4.89% -13.04% -1.91%

1990-
oct -0.41% 0.00% -12.50%
 BETA MANAGEMENT

The variability of the portfolio with r in asset one and 1-w in asset 2 is:

The

The covariance’s are:

Stock Cal. Reit Brown Group

Covariance (Vanguards Index, Stock) 0.0003 0.0024

Variability (Standard Deviation) of the portfolio (99%Vanguard, 1% Cal. REIT)

= [(.99²) (.0461²) + 2(.99) (.01) (.0003) + (.01²)(.0923²)]1/2

= 4.57%
The Variability (Standard Deviation) of the portfolio (99%Vanguard, 1% Brown Group)

= [(.99²) (.0461²) + 2(.99) (.01) (.0024) + (.01²) (.0817²)] 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.

Question.3

How the expected return for each stock might relates to its riskiness?

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 BETA MANAGEMENT

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 that’s 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 that’s why they want the result in portfolio context.

Stock Beta
Cal. Reit 0.1474
Brown Group 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:

California

r = RF + (rm-rf) β

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 BETA MANAGEMENT

r=0.03+ (4.505139-0.03)0.1474

r=0.6896

Slope 1
Brown
Group

r= RF+ (rm-rf)β

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.

TABLE 1

California

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 BETA MANAGEMENT

Months X X-e(X) [X-e(x)]^2

1989 Jan -28.26 -25.9946 675.7184
Feb -3.03 -0.76458 0.584588
Mar 8.75 11.01542 121.3394
Apr -1.47 0.795417 0.632688
May -1.49 0.775417 0.601271
Jun -9.09 -6.82458 46.57494
Jul 10.67 12.93542 167.325
Aug -9.38 -7.11458 50.6173
Sep 10.34 12.60542 158.8965
Oct -14.38 -12.1146 146.7631
Nov -14.81 -12.5446 157.3666
Dec -4.35 -2.08458 4.345488
1990 Jan -5.45 -3.18458 10.14157
Feb 5 7.265417 52.78628
Mar 9.52 11.78542 138.896
Apr -0.87 1.395417 1.947188
May 0 2.265417 5.132113
Jun 4.55 6.815417 46.4499
Jul 3.48 5.745417 33.00981
Aug 0 2.265417 5.132113
Sep -13.04 -10.7746 116.0916
Oct 0 2.265417 5.132113
Nov 1.5 3.765417 14.17836
Dec -2.56 -0.29458 0.086779

MEAN -2.265416667
VARIANCE 81.65621649 81.65622
S.D 9.230735982
Slope 0.1473

TABLE 3

Brown

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 BETA MANAGEMENT

Months X X-e(X) [X-e(x)]^2

1989 Jan 9.16 9.831667 96.66167
Feb 0.73 1.401667 1.964669
Mar -0.29 0.381667 0.145669
Apr 2.21 2.881667 8.304003
May -1.09 -0.41833 0.175003
Jun -0.65 0.021667 0.000469
Jul 2.22 2.891667 8.361736
Aug 0 0.671667 0.451136
Sep 1.88 2.551667 6.511003
Oct -7.55 -6.87833 47.31147
Nov -12.84 -12.1683 148.0683
Dec -1.7 -1.02833 1.057469
1990 Jan -15.21 -14.5383 211.3631
Feb 7.61 8.281667 68.586
Mar 1.11 1.781667 3.174336
Apr -0.51 0.161667 0.026136
May 12.71 13.38167 179.069
Jun 3.32 3.991667 15.9334
Jul 3.17 3.841667 14.7584
Aug -14.72 -14.0483 197.3557
Sep -1.91 -1.23833 1.533469
Oct -12.5 -11.8283 139.9095
Nov 17.26 17.93167 321.5447
Dec -8.53 -7.85833 61.7534

MEAN -0.67167
VARIANCE 63.91749 63.91749
S.D 8.166793 8.166793
Slope 1.16

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