Gregory is an analyst at a wealth management firm. One of hisclients holds a $10,000 portfolio that consists of four stocks. Theinvestment allocation in the portfolio along with the contributionof risk from each stock is given in the following table:
Stock | Investment Allocation | Beta | Standard Deviation |
|---|
| Atteric Inc. (AI) | 35% | 0.600 | 38.00% |
| Arthur Trust Inc.(AT) | 20% | 1.500 | 42.00% |
| Li Corp. (LC) | 15% | 1.100 | 45.00% |
| Transfer Fuels Co. (TF) | 30% | 0.500 | 49.00% |
Gregory calculated the portfolio’s beta as 0.825 and theportfolio’s expected return as 12.19%.
Gregory thinks it will be a good idea to reallocate the funds inhis client’s portfolio. He recommends replacing Atteric Inc.’sshares with the same amount in additional shares of Transfer FuelsCo. The risk-free rate is 6%, and the market risk premium is7.50%.
According to Gregory’s recommendation, assuming that the marketis in equilibrium, how much will the portfolio’s required returnchange?
0.26 percentage points
0.20 percentage points
0.32 percentage points
0.30 percentage points
Analysts’ estimates on expected returns from equity investmentsare based on several factors. These estimations also often includesubjective and judgmental factors, because different analystsinterpret data in different ways.
Suppose, based on the earnings consensus of stock analysts,Gregory expects a return of 13.43% from the portfolio with the newweights. Does he think that the revised portfolio, based on thechanges he recommended, is undervalued, overvalued, or fairlyvalued?
Undervalued
Fairly valued
Overvalued
Suppose instead of replacing Atteric Inc.’s stock with TransferFuels Co.’s stock, Gregory considers replacing Atteric Inc.’s stockwith the equal dollar allocation to shares of Company X’s stockthat has a higher beta than Atteric Inc. If everything else remainsconstant, the portfolio’s beta would   .
