You Are the Pension Fund Manager for a Major University

question 30

Essay

You are the pension fund manager for a major university with $100 million in an index fund that invests in the S&P 500 stocks.(The fund holds all the stocks in the index in proportion to their market values.)Due to recent pressure from student groups,the regents have decided to divest themselves of the stocks of firms that invest in South Africa.You estimate that this will eliminate 100 of the 500 stocks in your portfolio.You have been asked to evaluate the effect of the divestiture decision.You estimate that the correlation between acceptable and eliminated stocks is 0.6.You also have the following data:
$\begin{array}{lcc}&\underline{\text {Acceptable Stocks }}&\underline{\text {Eliminated Stocks}}\\\text { Number of Firms } & 400 & 100 \\\text { Total Market Value } & \$ 3 \text { billion } & \$ 2 \text { billion } \\\text { Average Beta } & 1.0 & 1.25 \\\text { Standard Deviation } & 25 \% & 30 \%\end{array}$

a. What will the effect of the divestment be on the beta of your portfolio? (Report the beta before and after the divestment.)
b. How will divestment affect the standard deviation of your portfolio? (Report the standard deviation before and after the divestment.)
c. Assume that the standard deviation of the overall market is 20%. What is the effect of divestment on the proportion of your portfolio's risk that is unsystematic? (Report the proportion before and after the divestment.)

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