11. Portfolio beta and weights Gregory is an analyst at a wealth management firm

Question

11. Portfolio beta and weights Gregory 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: nvestment Allocation 3596 20% 15% 30% Beta 0.600 1.600 1.100 0.400 Standard Deviation 23.00% 27.00% 30.00% 34.00% Stock Atteric Inc. (AI) Arthur Trust Inc. (AT) Li Corp. (LC) Transfer Fuels Co. (TF) Gregory calculated the portfolio's beta as 0.815 and the portfolio's expected return as 8.48%. thinks it will be a good idea to reallocate the funds in his client's portfolilo. He recommends replacing Atteric Inc. 's shares with the same amount in additional shares of Transfer Fuels Co. The risk-free rate is 4%, and the market risk premium is 5.50%. According to Gregory's recommendation, assuming that the market is in equilibrium, h renuired roturn chanae? ow much will the portfolio's

Explanation / Answer

Ans. 11 Calculation of Change in required return

Stock Revised Weight Beta Weighted Avg.

Arthur .20 1.6 .32

Li corp .15 1.1 .165   

Transfer fuels .65 .40 .26

.745

Risk free rate = 4%

Risk premium = 5.5%

Revised Rate of return = 4+5.5(.745) = 8.10%

Current required rate of return of = 8.48

Change in Required rate of return (8.48-8.10) = .38

Gregory Expects a return of 6.60% from the portfolio with the new weight.

Current Required rate of return is 8.48%

Expected Rate of Return is less than current required rate of return so stock is overvalued

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