Introduction In the world of investing, understanding portfolio beta is crucial for maximizing returns and managing risk. Beta measures the sensitivity of a portfolio's returns to the overall market's movements. It helps investors determine the level of systematic risk associated with their investments. In this article, we will delve into the case of an investor who starts with an initial wealth of $1000 and borrows an additional $500 at the risk-free rate to invest in the market portfolio. Our goal is to calculate the investor's portfolio beta and shed light on the implications for their investment strategy.
Calculating Portfolio Beta To calculate the portfolio beta, we need to understand the concept of market beta. Market beta, denoted as βm, measures the systematic risk of the overall market. It is considered to be 1 by definition. By investing in the market portfolio, an investor exposes themselves to the average risk of the market.
The formula to calculate portfolio beta is as follows: Portfolio Beta (βp) = (Weight of Investment in Asset 1 * Asset 1 Beta) + (Weight of Investment in Asset 2 * Asset 2 Beta) + ...