LOS e: Explain the advantage of dynamic over static asset allocation and evaluate the trade-offs of complexity and cost.

Q1. Consider two identical $10,000 portfolios, each with a 75% allocation to stock and a 25% cash allocation. One portfolio is being managed to a buy and hold strategy with an initial stock/total value ratio of 0.75. The other is being managed to a constant mix strategy with a desired stock/total value ratio of 0.75. Beta for the stock component of both portfolios is equal to one. Now, assume that the stock market instantly decreased from an index value of 1,000 to 900 and, a short while later, jumped back to the 1,000 level. The difference between the final value of the two portfolios is closest to which of the following?

A)   The constant mix portfolio will be worth $187.50 more than the buy-and-hold portfolio.

B)   There is no difference between the final value of the buy-and-hold portfolio and the constant mix portfolio.

C)   The constant mix portfolio will be worth $20.83 more than the buy-and-hold portfolio.

Q2. What is the major difference between dynamic asset allocation and static asset allocation? Dynamic asset allocation:

A)   considers more than one asset class while static asset allocation only considers one asset class at a time.

B)   considers asset and liability management simultaneously while static asset allocation does not.

C)   takes a multi-period view of the investment horizon while static asset allocation does not.

Q3. Dynamic asset allocation is most suitable for investors who:

A)   have insignificant liabilities.

B)   undertake the asset-liability approach to strategic asset allocation.

C)   have a long time horizon.