Question

Gregory is an analyst at a wealth management firm. One of his clients holds a $10,000 portfolio that consists of four stocks. The investment allocation in the portfolio along with the contribution of risk from each stock is given in the following table:

Stock	Investment Allocation	Beta	Standard Deviation
Atteric Inc. (AI)	35%	0.600	38.00%
Arthur Trust Inc.(AT)	20%	1.500	42.00%
Li Corp. (LC)	15%	1.100	45.00%
Transfer Fuels Co. (TF)	30%	0.500	49.00%

Gregory calculated the portfolio’s beta as 0.825 and the portfolio’s expected return as 12.19%.

Gregory thinks it will be a good idea to reallocate the funds in his client’s portfolio. He recommends replacing Atteric Inc.’s shares with the same amount in additional shares of Transfer Fuels Co. The risk-free rate is 6%, and the market risk premium is 7.50%.

According to Gregory’s recommendation, assuming that the market is in equilibrium, how much will the portfolio’s required return change?

0.26 percentage points

0.20 percentage points

0.32 percentage points

0.30 percentage points

Analysts’ estimates on expected returns from equity investments are based on several factors. These estimations also often include subjective and judgmental factors, because different analysts interpret data in different ways.

Suppose, based on the earnings consensus of stock analysts, Gregory expects a return of 13.43% from the portfolio with the new weights. Does he think that the revised portfolio, based on the changes he recommended, is undervalued, overvalued, or fairly valued?

Undervalued

Fairly valued

Overvalued

Suppose instead of replacing Atteric Inc.’s stock with Transfer Fuels Co.’s stock, Gregory considers replacing Atteric Inc.’s stock with the equal dollar allocation to shares of Company X’s stock that has a higher beta than Atteric Inc. If everything else remains constant, the portfolio’s beta would   .

Answer 1