3. You are considering three stocks-A, B, and C-for possible inclusion in your investment portfolio. Stock A has a beta of 0.80, stock B has a beta of 1.40, and stock C has a beta of - 0.30.

a. Rank these stocks from the most risky to the least risky.

b. If the return on the market portfolio increased by 12%, what change would you expect in the return for each of the stocks?

c. If the return on the market portfolio decreased by 5%, what change would you expect in the return for each of the stocks?

d. If you believed that the stock market was getting ready to experience a significant decline, which stock would you probably add to your portfolio? Why?

e. If you anticipated a major stock market demand, which stock would you add to your portfolio? Why?

A) In the short run, the lower the beta, the lower the stock risk.

Stock B (-0.30)

Stock A (0.80)

Stock C (1.40)

But in the long run, since the market tends to have a positive growth rate, a negative beta tends to be more risky. Generally, negative betas are extremely uncommon and only gold related stocks tend to have negative betas. Gold is more secure than currency, so in the short run a negative beta is more secure. But in the long run, gold related stocks yield very low returns, which makes them unfit as a long term investment. Even zero risk portfolios (US treasuries) provide higher yields than gold in the long run.

b. If the return on the market portfolio increased by 12%, what change would you expect in the return for each of the stocks?

Stock B's return would decrease by - 0.30 x 12% = - 3.6%

Stock A's return would increase by 0.8 x 12% = 9.6%

Stock C's return would increase by 1.40 x 12% = 16.8%

c. If the return on the market portfolio decreased by 5%, what change would you expect in the return for each of the stocks?

Stock B's return would increase by - 0.30 x - 5% = 1.5%

Stock A's return would decrease by 0.8 x - 5% = - 4%

Stock C's return would decrease by 1.40 x - 5% = - 7%

d. If you believed that the stock market was getting ready to experience a significant decline, which stock would you probably add to your portfolio? Why?

Stock B, since its beta is negative, as the market declines, you can earn higher yields. E. g. every time the economy is in recession, gold related stocks increase their value.

e. If you anticipated a major stock market demand, which stock would you add to your portfolio? Why?

Stock C, since it has the highest beta which makes it the most risky but also yields higher results when the stock market is rising.