Rafael 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% | 0.750 | 23.00% |
| Arthur Trust Inc. (AT) | 20% | 1.400 | 27.00% |
| Li Corp. (LC) | 15% | 1.300 | 30.00% |
| Baque Co. (BC) | 30% | 0.400 | 34.00% |
Rafael calculated the portfolio’s beta as 0.8575 and theportfolio’s expected return as 8.72%.
Rafael 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 Baque Co. Therisk-free rate is 4%, and the market risk premium is 5.50%.
According to Rafael’s recommendation, assuming that the marketis in equilibrium, how much will the portfolio’s required returnchange? (Note: Round your intermediate calculations to two decimalplaces.)
0.78 percentage points
0.53 percentage points
0.84 percentage points
0.68 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,Rafael expects a return of 6.54% from the portfolio with the newweights. Does he think that the revised portfolio, based on thechanges he recommended, is undervalued, overvalued, or fairlyvalued?
Overvalued
Undervalued
Fairly valued
Suppose instead of replacing Atteric Inc.’s stock with BaqueCo.’s stock, Rafael considers replacing Atteric Inc.’s stock withthe equal dollar allocation to shares of Company X’s stock that hasa higher beta than Atteric Inc. If everything else remainsconstant, the portfolio’s beta would ____ , and the required returnfrom the portfolio would____ .
