The standard deviation of the market index portfolio is 20%. Stock A has a beta of 1.5 and a residual standard deviation of 30%.
a) What would make for a larger increase in the stock’s variance: an increase of .15 in its beta or an increase of 3% in its residual standard deviation?
b) An investor who currently holds the market-index portfolio decides to reduce the portfolio allocation to the market index to 90%, and to incest in stock A. Which of the changes in (a) will have a greater impact on the portfolio’s standard deviation?