Rafael is an analyst at a wealth management firm. One of his clients holds a $10
ID: 2788500 • Letter: R
Question
Rafael 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 Investment Allocation 35% 2090 15% 30% Standard Deviation 38.00% 42.00% 45.00% 49.00% Stock Atteric Inc. (AI) Arthur Trust Inc. (AT) Lobster Supply Corp. (LSC) Baque Co. (BC) Beta 0.750 1.500 1.200 0.500 Rafael calculated the portfolio's beta as 0.893 and the portfolio's expected return as 12.70% 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 6%, and the market risk premium is 7.50% According to Rafael's recommendation, assuming that the market is in equilibrium, how much will the portfolio's required return change? 0.76 percentage points O 0.82 percentage points O 0.66 percentage points O 0.52 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 10.54% 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:? Fairly valued Overvalued Undervalued 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 portfolio's risk wouldExplanation / Answer
1.
After replacement weight of Baque Co. become 65%. So, new beta pf portfolio is calculated below:
Beta = (20% × 1.50) + (15% × 1.20) + (65% × 0.50)
= 0.30 + 0.18 + 0.325
=0.805
New beta of portfolio is 0.805.
New expected return = 6% + (7.50% × 0.805)
= 6% + 6.04%
= 12.04%
New expected return is 12.04%.
Change in expected return = 12.70% - 12.04%
= 0.66%.
Change in expected return is 0.66%.
Option (C) is correct answer.
b.
Required return form portfolio is 10.54% and new expected rate of return is 12.04%. Since, Expected rate of return is higher than required rate of return, so, portfolio is Overvalued.
Option (C) is correct answer.
c.
if beta of portfolio X is higher than beta of Atteric then overall risk of portfolio will increase.
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