Rafael is an analyst at a wealth management firm. One of his clients holds a $7,

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 Investment Allocation 35% 20% 15% 30% Standard Deviation 53.00% 57.00% 60.00% 64.00% Stock Atteric Inc. (AI) Arthur Trust Inc. (AT) Li Corp. (LC) Baque Co. (BC) Beta 0.750 1.400 1.200 0.300 Rafael calculated the portfolio's beta as 0.813 and the portfolio's expected return as 8.47% 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? O 1.08 percentage points O 0.68 percentage points O 1.00 percentage points O 0.87 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 6.10% 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? Overvalued Undervalued O Fairly valued 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 beta would portfolio would and the required return from the

Explanation / Answer

1.
Change in beta=0.35*(0.3-0.75)=-0.1575
Change in required return=-0.1575*5.5%=-0.866%
Option D

2.
Required return=4%+0.813*5.5%=8.4715%
Overvalued because expected return is less than required return

3.
increase
increase

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