Rafael 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 35% Beta 0.600 Stock Atteric Inc. (AI) Arthur Trust Inc. (AT) Li Corp. (LC) Transfer Fuels Co. (TF) Standard Deviation 23.00% 27.00% 30.00% 20% 1.600 15% 1.200 30% 0.500 34.00% Rafael calculated the portfolio's beta as 0.8600 and the portfolio's expected return as 8.73%. 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 Transfer Fuels 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? (Note: Round your intermediate calculations to two decimal places.) 0.15 percentage points 0.22 percentage points 0.19 percentage points 0.24 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 7.04% 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 Suppose instead of replacing Atteric Inc.'s stock with Transfer Fuels 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 and the required return from the portfolio would Wilson holds a portfolio that invests equally in three stocks (WA = wb = wc = 1/3). Each stock is described in the following table: Stock Beta A 0.5 Standard Deviation Expected Return 23% 7.5% 38% 12.0% B 1.0 2.0 45% 14.0% An analyst has used market-and firm-specific information to generate expected return estimates for each stock. The analyst's expected return estimates may or may not equal the stocks' required returns. You've also determined that the risk-free rate (TRF) is 4%, and the market risk premium (RPM) is 5%. Given this information, use the following graph of the security market line (SML) to plot each stock's beta and expected return on the graph. Tool tip: Mouse over the points in the graph to see their coordinates. 2 20 18 Stook A 16 14 12 Stock B RATE OF RETURN (Percent) 10 Stock C 2 0 0 0.2 0.4 0.6 1.4 1.8 1.8 2.0 0.8 1.0 1.2 RISK (Beta) A stock is in equilibrium if its expected return its required return. In general, assume that markets and stocks are in equilibrium (or fairly valued), but sometimes investors have different opinions about a stock's prospects and may think that a stock is out of equilibrium (either undervalued or overvalued). Based on the analyst's expected return estimates, Stock A is Stock Bis Stock C is in equilibrium and fairly valued. and
