Neha is an analyst at a wealth management firm. One of her clients 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: Stock Investment Allocation Beta Standard Deviation Atteric Inc. 35% 0.750 0.53% Arthur Inc. 20% 1.400 0.57% Li Corp. 15% 1.300 0.60% Transfer Fuels Co. 30% 0.300 0.64% Neha calculated the portfolio’s beta as 0.828 and the portfolio’s expected return as 8.55%. Neha thinks it will be a good idea to reallocate the funds in her client’s portfolio. She recommends replacing Atteric Inc.’s shares with the same amount in additional shares of Transfer Fuels Co. The risk-free rate is 4.00%, and the market risk premium is 5.50%. 1. According to Neha’s recommendation, assuming that the market is in equilibrium, how much will the portfolio’s required return change? 0.86% 0.67% 1.07% 0.99% 2. 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, Neha expects a return of 7.68% 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 3. Suppose instead of replacing Atteric Inc.’s stock with Transfer Fuels Co.’s stock, Neha 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 required return from the portfolio would .
Neha is an analyst at a wealth management firm. One of her clients 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: Stock Investment Allocation Beta Standard Deviation Atteric Inc. 35% 0.750 0.53% Arthur Inc. 20% 1.400 0.57% Li Corp. 15% 1.300 0.60% Transfer Fuels Co. 30% 0.300 0.64% Neha calculated the portfolio’s beta as 0.828 and the portfolio’s expected return as 8.55%. Neha thinks it will be a good idea to reallocate the funds in her client’s portfolio. She recommends replacing Atteric Inc.’s shares with the same amount in additional shares of Transfer Fuels Co. The risk-free rate is 4.00%, and the market risk premium is 5.50%. 1. According to Neha’s recommendation, assuming that the market is in equilibrium, how much will the portfolio’s required return change? 0.86% 0.67% 1.07% 0.99% 2. 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, Neha expects a return of 7.68% 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 3. Suppose instead of replacing Atteric Inc.’s stock with Transfer Fuels Co.’s stock, Neha 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 required return from the portfolio would .
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Question
Neha is an analyst at a wealth management firm. One of her clients 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:
|
Stock
|
Investment Allocation
|
Beta
|
Standard Deviation
|
|---|---|---|---|
| Atteric Inc. | 35% | 0.750 | 0.53% |
| Arthur Inc. | 20% | 1.400 | 0.57% |
| Li Corp. | 15% | 1.300 | 0.60% |
| Transfer Fuels Co. | 30% | 0.300 | 0.64% |
Neha calculated the portfolio’s beta as 0.828 and the portfolio’s expected return as 8.55%.
Neha thinks it will be a good idea to reallocate the funds in her client’s portfolio. She recommends replacing Atteric Inc.’s shares with the same amount in additional shares of Transfer Fuels Co. The risk-free rate is 4.00%, and the market risk premium is 5.50%.
1. According to Neha’s recommendation, assuming that the market is in equilibrium, how much will the portfolio’s required return change?
0.86%
0.67%
1.07%
0.99%
2. 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, Neha expects a return of 7.68% 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
3. Suppose instead of replacing Atteric Inc.’s stock with Transfer Fuels Co.’s stock, Neha 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 required return from the portfolio would .
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