Question

6. Portfolio beta and weights Aa Aa Brandon is an analyst at a wealth management firm. One of his clients holds a $5,000 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 Beta Standard Deviation 38.00% 35% 0.750 Stock Atteric Inc. (AI) Arthur Trust Inc. (AT) Lobster Supply Corp. (LSC) Baque Co. (BC) 20% 1.600 42.00% 15% 1.200 45.00% 30% 0.300 49.00% Brandon calculated the portfolio's beta as 0.853 and the portfolio's expected return as 12.40%. 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 Baque Co. The risk-free rate is 6%, and the market risk premium is 7.50%. According to Brandon's recommendation, assuming that the market is in equilibrium, how much will the portfolio's required return change? 1.37 percentage points 1.19 percentage points 1.48 percentage points 0.93 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, Brandon expects a return of 12.71% 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

Answer 1

CAPM Return (r) Rf+BxRp Here, Risk free rate of return (RF) Beta of the stock (B) Market risk premium (Rp) 6.00% 0.70 7.50% CAPM Return (0) 11.21% 6%+0.70*7.50% Hence, correct optionn is 1.19 percentage points (12.40%-11.21%) CAPM return 11.21% is lower than expected return 12.71%. Hence, correct option is Undervalued. Portfolio risk would increase

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