1. Portfolio beta and weights Rafael is an analyst at a wealth management fim. O
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1. Portfolio beta and weights Rafael is an analyst at a wealth management fim. 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 Standard Deviation 53.00% 57.00% 60.00% 64.00% Stock Atteric Inc. (AI) Arthur Trust Inc. (AT) Li Corp. (LC) Baque Co. (BC) Allocation 35% 2096 15% 30% Beta 0.600 1.500 1.200 0.400 Rafael calculated the portfolio's beta as 0.810 and the portfolio's expected return as 12.08% 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 6%, and the market risk premium is 7.50%. ation, assuming that the market is in equilibrium, how much will the portfolio's According to Rafael's required return change? O 0.66 percentage points 1 percentage points O 0.41 percentage points 0.53 percentage points O 0.6 Analysts' estimates on expected returns from equity investments are based on several factors. These estimations also often indlude subjective and judgmental factors, because different analysts interpret data in different ways. Suppose, based on the eamings consensus of stock analysts, Rafael expects a return of 13.05% 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 O Undervalued 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 decrease Flash Flayer MAC 30,0,0,113 Q3 3.34.1 2004-2016 Aplis. All rights reserved Grade It Now Save & Continue 2013 Czngage Learning except as noted. Al rights reserved.Explanation / Answer
a.
Current Portfolio beta is 0.810 and expected rate of return is 12.08%.
Now Rafeal replace Atteric shares in baque Co., so after replacement weight of Baque co. will be 65%.
So, New Beta of portfolio is calculated below:
New Beta = (20% × 1.50) + (15% × 1.20) + (65% × 0.40)
= 0.30 + 0.18 + 0.26
= 0.74
New Beta of portfolio will be 0.74.
Change in expected rate = Risk premium × (Old Beta - New Beta)
= 7.50% × (0.810 - 0.740)
= 7.50% × 0.07
= 0.53%
Expected rate of return reduce by 0.53%.
Option (D) is correct answer.
b.
New required rate = 6% + (7.50% × 0.74)
= 6% + 5.55%
= 11.55%
New required rate of return is 11.55% and expected rate of return is 13.05%. Since, expected return of new portfolio is higher than required rate of return so new portfolio is undervalued.
Option (C) is correct answer.
c.
Now Suppose instead of replacing Atteric Inc. stock with Baque Co Stock, Rafeal replacing Atteric Inc.'s stock with the equal dollar allocation to shares of company X's Stock that has a higher beta than Atteric's stock. if everything remains constant, the required return of new portfolio would be higher than current required rate of return.
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