Question

The fill in choices for the last two questions are both increase/decrease

10. Portfolio beta and weights Brandon 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 Standard Deviation 23.00% 35% Stock Atteric Inc. (AI) Arthur Trust Inc. (AT) Li Corp. (LC) Transfer Fuels Co. (TF) Beta 0.750 1.500 20% 27.00% 15% 1.100 30.00% 30% 0.500 34.00% Brandon calculated the portfolio's beta as 0.8775 and the portfolio's expected return as 8.83%. Brandon 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 Transfer Fuels Co. The risk-free rate is 4%, and the market risk premium is 5.50%. According to Brandon's recommendation, assuming that the market is in equilibrium, how much will the portfolio's required return change? (Note: Round your intermediate calculations to two decimal places.) O 0.60 percentage points O 0.48 percentage points O 0.55 percentage points O 0.37 percentage points

Answer 1

New portfolio beta =Weighted average beta

= 1.5*20% + 1.1*15%+0.5*65%

= 0.79

New portfolio return = risk free rate + beta*market risk premium

= 4% + 0.79*5.50%

= 8.345%

Hence, change in required return = 8.83% - 8.345%

= 0.485 percentage points

i.e. 0.48 percentage points

He expects return to be 6.85% but CAPM return is 8.345%

Hence, he thinks that revised portfolio is overvalued

Portfolio beta would INCREASE and hence required return will also INCREASE

Since portfolio beta is equal to weighted average beta. With inclusion of higher beta stock, portfolio beta would increase