Overview of Equity Portfolio Management

Correct Answer: Replace the stock with the new stock and slightly reduce the allocation to other high-beta stocks in the portfolio to maintain the overall risk profile.

The most appropriate action for Emma would be to replace the stock with the new stock and slightly reduce the allocation to other high-beta stocks in the portfolio to maintain the overall risk profile. By replacing the stock with a higher beta and expected return, Emma can potentially enhance the portfolio's risk-adjusted return. However, to maintain a similar risk profile, she should slightly reduce the allocation to other high-beta stocks in the portfolio. This will help offset the increased risk introduced by the new stock. The other options are less suitable because: - Increasing the allocation to low-beta stocks to offset the higher risk of the new stock may reduce the portfolio's overall expected return, which goes against Emma's primary objective. - Keeping the current stock and not making any changes would miss the opportunity to potentially improve the portfolio's risk-adjusted return.

Correct Answer: Replacing the stock will increase both the expected return and the beta of the portfolio. The new stock's higher beta and expected return will contribute to a higher overall portfolio expected return, but also increase the portfolio's sensitivity to market movements, thus increasing its risk profile.

Replacing the stock with a new one that has a higher beta (1.3 vs 0.9) and a higher expected return (14% vs 10%) will increase both the portfolio's expected return and risk profile. The portfolio's expected return will increase because the new stock has a higher expected return than the one being replaced. Even though it's just one stock out of 50, it will still contribute to a higher overall expected return for the portfolio. The portfolio's risk profile, as measured by its beta, will also increase. The new stock's higher beta indicates that it is more sensitive to market movements compared to the stock being replaced. This higher sensitivity will translate to a higher overall portfolio beta, thus increasing the portfolio's risk profile. The other two answers are incorrect because: - Decreasing the expected return while increasing risk is illogical given the characteristics of the new stock compared to the one being replaced. - The change will have an impact, albeit small, on the portfolio's risk and return profile. Even one stock change can shift these metrics, especially when the new stock's characteristics differ significantly from the replaced stock.

Correct Answer: Identify a stock in the current portfolio with a beta lower than 1.2 and replace it with the new stock, while simultaneously adjusting the weights of other holdings to maintain the overall portfolio beta at 1.2.

The most appropriate action for Sarah to take is to identify a stock in the current portfolio with a beta lower than 1.2 and replace it with the new stock, while simultaneously adjusting the weights of other holdings to maintain the overall portfolio beta at 1.2. By doing this, Sarah can introduce the new stock with a higher expected return into the portfolio without significantly altering the overall risk profile. The key is to make offsetting adjustments to other holdings to keep the portfolio's beta at its current level of 1.2. Adding the new stock without making any other changes is not the best option, as even a small 4% allocation to a stock with a higher beta can incrementally increase the portfolio's overall risk. Replacing a portion of the portfolio with low-beta stocks or fixed-income securities to offset the new stock's risk would likely drag down the portfolio's expected return, which goes against Sarah's objective of maintaining the current risk-return profile.