Please answer all parts to the question. If possible show explanation. Thanks! C

Question

Please answer all parts to the question. If possible show explanation. Thanks!

Conrad holds a $20.00 portfolio that consists of four stocks, His investment in each stock, as well as each stock's beta, is shown below: If all the stocks in the portfolio were equally weighted, which of these stocks would have the least amount of stand-alone risk? If all the stocks in Conrad's portfolio were equally weighted, which of these stocks would contribute the least risk to the portfolio? Conrad is thinking about reallocating the funds in his portfolio. He plans to sell his stake in Darken Enterprises and put that money into Barrington Inc. Assuming the market is in equilibrium and Conrad changes his portfolio, how much will his portfolio's required return change? Suppose an analyst believes that the expected return on the portfolio is actually 14.80%. Does this analyst think the portfolio is undervalued, overvalued, or fairly valued?

Explanation / Answer

a) Standard deviaiton measures the total stand-alone risk. The higher the deviaiton the higher the stand-alone risk for the stock. Hence, the Aramis Airlines will have the least Stand-alone risk. b) The Company with least beta will contribute to less risk. Dartan enterprise will contribute to less risk. c) Calculating the Portfolio beta: Total investment in all the four stocks = $20,000 Weight of Aramis Airlines (Wa) = $3,000 / $20,000                                                         = 0.15 Weight of Barrington (Wb) = $8,000 / $20,000                                                = 0.4 Weight of Carrow (Wc) = $5,000 / $20,000                                           = 0.25 weight of Dartan (Wd) = $4,000 / $20,000                                        = 0.2 Portfolio beta = (Wa * Beta of A) + (Wb * Beta of B) + (Wc * Beta of C) + (Wd * Beta of D)                          = (0.15 * 0.8) + (0.4 * 1.5) + (0.25*1.2) + (0.2 * 0.7)                         = 0.12 + 0.6 + 0.3 + 0.14                         = 1.16 Therefore, the portfolio beta value is 1.16 Calculating the required rate of return using CAPM,                                   Re = Rf + Beta [Rm - Rf] where Re = required return            Rf = Risk-free rate            Beta = Risk co-efficient    [Rm-Rf] = Market risk premium Calculating the required rate of return using CAPM,                                   Re = Rf + Beta [Rm - Rf] where Re = required return            Rf = Risk-free rate            Beta = Risk co-efficient    [Rm-Rf] = Market risk premium Portfolio required return = Rf + Portfolio beta [Rm - Rf]                                             = 0.05 + 1.16 (0.06)                                             = 0.05 + 0.0696                                             = 0.1196 or 11.96% d) Now, weight of Barrington = $8,000 + $4,000                                                    = $12,000 If the market is in equillibrium, then the beta value will be equal to "1" Portfolio required return = = Rf + Portfolio beta [Rm - Rf]                                             = 0.05 + 1 (0.06)                                             = 0.05 + 0.06                                             = 0.11 or 11% Therefore, the portfolio return changes by 0.96% e) According to the analyst the portfolio is undervalued because the portfolio expected return is just 11.96%                                             = 0.05 + 1 (0.06)                                             = 0.05 + 0.06                                             = 0.11 or 11% Therefore, the portfolio return changes by 0.96% e) According to the analyst the portfolio is undervalued because the portfolio expected return is just 11.96%

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