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%	1.400	42.00%
Li Corp. (LC)	15%	1.300	45.00%
Transfer Fuels Co. (TF)	30%	0.500	49.00%

Brandon calculated the portfolio’s beta as 0.888 and the portfolio’s expected return as 12.6600%.

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 Transfer Fuels Co. The risk-free rate is 6%, and the market risk premium is 7.50%.

1. 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.)

a. 0.7590 percentage points

b. 0.6600 percentage points

c 0.5148 percentage points

d. 0.8184 percentage points

2. 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 13.50% 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?

a.Overvalued

b.Undervalued

c. Fairly valued

3. Suppose instead of replacing Atteric Inc.’s stock with Transfer Fuels 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 required return from the portfolio would _______ .

Answer 1