Question

4. Portfolio beta and welghts 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: Beta Standard Deviation Investment Allocation 35% 20% 0.750 Stock Atteric Inc. (AI) Arthur Trust Inc. (AT) Lobster Supply Corp. (SC) Baque Co. (BC) 23.00% 1.600 27.00% 15% 30.00% 1.300 0.300 30% 34.00% Rafael Calculated the portfolio's beta as 0.868 and the portfolio's required return as 8.7740% 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? (Note: Do not round your intermediate calculations.) O 0.9994 percentage points O 0.8690 percentage points O 1.0776 percentage points 0.6778 percentage points MacBook Air

Answer 1

New Allocation on Baque co = 30%+35% = 65%
Beta after new allocation =20%*1.60+15%*1.30+65%*0.3 = 0.71
New Required rate = Risk free rate + Beta* Market risk premium =4%+0.71* 5.5% =7.905%

The change in required rate =8.7740%- 7.905% = 0.8690 percentage points

The project is overvalued if Brandon expects 6.41%

If Higher beta is chosen the portfolio risk would increase.