Portfolio beta and weights
Brandon is an analyst at a wealth management firm. One of hisclients holds a $5,000 portfolio that consists of four stocks. Theinvestment allocation in the portfolio along with the contributionof risk from each stock is given in the following table:
Stock | Investment Allocation | Beta | Standard Deviation |
|---|
| Atteric Inc. (AI) | 35% | 0.900 | 38.00% |
| Arthur Trust Inc. (AT) | 20% | 1.500 | 42.00% |
| Li Corp. (LC) | 15% | 1.300 | 45.00% |
| Transfer Fuels Co. (TF) | 30% | 0.400 | 49.00% |
Brandon calculated the portfolio’s beta as 0.930 and theportfolio’s expected return as 9.1150%.
Brandon thinks it will be a good idea to reallocate the funds inhis client’s portfolio. He recommends replacing Atteric Inc.’sshares with the same amount in additional shares of Transfer FuelsCo. The risk-free rate is 4%, and the market risk premium is5.50%.
According to Brandon’s recommendation, assuming that the marketis in equilibrium, how much will the portfolio’s required returnchange? (Note: Do not round your intermediate calculations.)
A. 0.9625 percentage points
B. 1.1935 percentage points
C. 0.7508 percentage points
D. 1.1069 percentage points
Analysts’ estimates on expected returns from equity investmentsare based on several factors. These estimations also often includesubjective and judgmental factors, because different analystsinterpret data in different ways.
Suppose, based on the earnings consensus of stock analysts,Brandon expects a return of 9.65% from the portfolio with the newweights. Does he think that the required return as compared toexpected returns is undervalued, overvalued, or fairly valued?
A. Overvalued
B. Fairly valued
C. Undervalued
Suppose instead of replacing Atteric Inc.’s stock with TransferFuels Co.’s stock, Brandon considers replacing Atteric Inc.’s stockwith the equal dollar allocation to shares of Company X’s stockthat has a higher beta than Atteric Inc. If everything else remainsconstant, the portfolio’s risk would ____________ .(decrease or Increase)
