Question

Brandon is an analyst of a wealth management firm. One of his cilents holds a $5,000 portfollo 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: Brandon calculated the portfolio's beta 350.818 and the portfollo's required return as 8.4990%. Brandon thinks it will be a good idea to reallocate the funds in his client's portfollo. He recommends replacing Atteric inc.'s ahares with the same amount in additionol shares of Baque Co. The risk-free rate is 4%, and the Tharket risk premlum is 5.50%. According to Brandon's recommendation, assuming that the market is in equilibrium, how much will the portfolio's required return change? (Note: Do not round your intermediate calculations.) According to Brandon's recommendation, assuming that the market is in equilibrium, how much will the portfolio's required return change? (Note: Do not round your intermediate calculations.) 0.9994 percentage points 0.6778 percentage points 0,8690 percentage points 1.0776 percentage points Analysts' estimates on expected returns from equity investments are based on several factors. These estimations alse 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 6.13% from the portlolio with the new weights. Dees he think that the required return as compared to expected returns is undervalued, overvalued, or fairly valued? Fairly valued Undervalued Overvalued Suppose instead of replacing Attecic Incis stock with Baque. Coi's stock, Brandon considers replacing Atteric Inci's stock with the equal dollar allocation to shares of Company X 's stock that has a higher beta than Atterle thc. If everything else remains constant, the portfolio's beta would

Answer 1

Upon rebalancing a client's portfolio, calculating the new required return depends on the CAPM formula. If the beta does not change, the required return should theoretically remain the same. If Brandon expects lower returns than the required return, the portfolio is overvalued.

Step-by-step explanation:

When Brandon, an analyst at a wealth management firm, considers reallocating funds by replacing Atteric Inc.'s shares with Baque Co., he must consider how the portfolio's required return will change.

The necessary calculation is based on the Capital Asset Pricing Model (CAPM) which states that the expected return on a portfolio is equal to the risk-free rate plus the product of the portfolio's beta coefficient and the market risk premium.

The current portfolio's beta is 350.818, and the required return is 8.4990%. If Brandon replaces one stock with another that has the same beta, the portfolio beta will remain the same.

Therefore, when calculating the new required return, if the market conditions (i.e., market risk premium and risk-free rate) do not change, the required return of the portfolio should theoretically remain the same: required return = risk-free rate + (portfolio beta × market risk premium).

However, if he recommends replacing with a stock with a different beta or the market risk premium changes, these would affect the portfolio's required return.

In terms of valuation, if Brandon expects a return of 6.13% from the portfolio with new weights and the required return is 8.4990%, this portfolio would be considered overvalued, because the expected return is less than the required return. Should a stock from Company X with a higher beta than Atteric replace Atteric's stocks, the portfolio's beta will increase, leading to a potentially higher required return due to increased risk.