Question

Brandon is an analyst at a wealth management firm. One of his clients holds a $5,000 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%	0.750	38.00%
Arthur Trust Inc. (AT)	20%	1.500	42.00%
Li Corp. (LC)	15%	1.100	45.00%
Baque Co. (BC)	30%	0.300	49.00%

Brandon calculated the portfolio’s beta as 0.818 and the portfolio’s expected return as 8.4990%.

Brandon 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 Baque Co. The risk-free rate is 4%, and the market risk premium is 5.50%.

According to Brandon’s recommendation, assuming that the market is in equilibrium, how much will the portfolio’s required return change? (Note: Do not round your intermediate calculations.)

0.6778 percentage points

1.0776 percentage points

0.9994 percentage points

0.8690 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, Brandon expects a return of 6.13% from the portfolio with the new weights. Does he think that the required return as compared to expected returns is undervalued, overvalued, or fairly valued?

Undervalued

Overvalued

Fairly valued

Suppose instead of replacing Atteric Inc.’s stock with Baque Co.’s stock, Brandon 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 _____Increase/decrease.

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Answer 1