5. Portfolio beta and weights Aa Aa Rafael is an analyst at a wealth management

Question

5. Portfolio beta and weights Aa Aa Rafael is an analyst at a wealth management firm. One of his dients 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: Standard Deviation 23.00% 27.00% 30.00% 34.00% Stock Atteric Inc. (AI) Arthur Trust Inc. (AT) Lobster Supply Corp. (LSc) Baque Co. (BC) Allocation 3596 20% 15% 30% Beta 0.600 1.500 1.100 0.500 Rafael calculated the portfolio's beta as 0.825 and the portfolio's expected return as 8.54%. 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? 0.22 percentage points O 0.24 percentage points O 0.15 percentage points O 0.19 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 9.85% 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? O Undervalued O Overvalued O Fairly valued

Explanation / Answer

Investment Allocation Beta Portfolio Beta Atteric Inc.(AI) 35% 0.6 0.210 Arthur Trust Inc,(AT) 20% 1.5 0.300 Lobster supply corp.(LSC) 15% 1.1 0.165 Baque Co.(BC) 30% 0.5 0.150 0.825 With Change in structure Arthur Trust Inc,(AT) 20% 1.5 0.300 Lobster supply corp.(LSC) 15% 1.1 0.165 Baque Co.(BC) 65% 0.5 0.325 0.790 CAPM Return will be = 4% + 0.790 x 5.5% = 4% + 4.345% = 8.345% or 8.35% Portfoilio required return change = 8.35% - 8.54% = 0.19% ans is D Since new expected return is 9.85% while CAPM return is only 8.35%, so its Undervalued.

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