Question

Rafael is an analyst at a wealth management firm. One of his clients holds a $7,500 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	23.00%
Arthur Trust Inc. (AT)	20%	1.600	27.00%
Lobster Supply Corp. (LSC)	15%	1.300	30.00%
Baque Co. (BC)	30%	0.300	34.00%

Rafael calculated the portfolio’s beta as 0.868 and the portfolio’s required return as 8.7740%.

Rafael 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 Rafael’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.)

0.9994 percentage points

0.8690 percentage points

1.0776 percentage points

0.6778 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, Rafael expects a return of 6.41% 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?

Fairly valued

Undervalued

Overvalued

Suppose instead of replacing Atteric Inc.’s stock with Baque Co.’s stock, Rafael 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 required return from the portfolio would (Increase, decrease .

Answer 1

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