|
LOS h: Select and justify an appropriate set of asset classes for an investor.
Q1. Cecil Boller is the portfolio manager for a $500 million defined benefit pension fund. Boller has been conducting a great deal of analysis to select the appropriate allocation for the fund. He has come up with the following long-term expectations for various asset classes.
|
Asset Class |
Expected
Return |
Expected
Standard
Deviation |
Correlations |
|
1 |
2 |
3 |
4 |
5 |
|
1 |
U.S. equity |
12.00% |
16.00% |
1.00 |
|
|
|
|
|
2 |
U.S. corporate bonds |
8.25% |
6.50% |
0.32 |
1.00 |
|
|
|
|
3 |
Int’l equities |
14.00% |
18.00% |
0.46 |
0.22 |
1.00 |
|
|
|
4 |
Int’l bonds |
9.25% |
12.25% |
0.23 |
0.56 |
0.32 |
1.00 |
|
|
5 |
Alternative Investments |
11.50% |
21.00% |
0.25 |
0.11 |
0.08 |
0.06 |
1.00 |
Based on these expectations, Boller identifies an efficient frontier with four corner portfolios with the characteristics shown below. The risk-free rate is assumed to be equal to the T-bill rate of 3.0%.
|
Corner
Portfolio |
Expected
Return |
Expected
Standard
Deviation |
Sharpe
Ratio |
Asset Class Weights |
|
1 |
2 |
3 |
4 |
5 |
|
1 |
14.00% |
18.00% |
0.611 |
0% |
0% |
100% |
0% |
0% |
|
2 |
13.66% |
16.03% |
0.665 |
0% |
0% |
86.36% |
0% |
13.64% |
|
3 |
12.79% |
13.00% |
0.753 |
21.48% |
0.00% |
52.01% |
5.24% |
21.27% |
|
4 |
10.54% |
8.14% |
0.926 |
9.40% |
51.30% |
26.55% |
0% |
12.76% |
Boller has determined that the fund has a spending rate of 7.5%. Inflation is expected to be 2.5% per year, and the cost of managing the fund is expected to be 0.50%. The expected return on the portfolio is therefore (1.075)(1.025)(1.005) – 1 = 10.74%. Boller has also stated that he does not want the standard deviation of the pension portfolio to exceed 9.0% and there is a constraint against short selling.
Conclusion 1: The weight given to U.S. equity in the pension portfolio should be greater than 11.0%.
Conclusion 2: The weight given to corporate bonds in the portfolio should be exactly 30.78%.
Conclusion 3: The weight given to alternative investments in the portfolio should be greater than 13.0%.
Given this information, which of the following conclusions drawn by Boller are CORRECT?
A) Conclusion 3 only.
B) Conclusions 1 and 2 only.
C) Conclusions 1 and 3 only.
Q2. Taylor Robinson, age 60, recently retired from her position as director of public giving for United Electric Power, a large public utility company. Robinson has accumulated $2,000,000 in her 401(k) portfolio for retirement. Robinson estimates that she will need $50,000 in today’s dollars to live comfortably. Inflation is expected to be 2.5% annually, and Robinson is in the 20% tax bracket. With her background in public giving, Robinson has two favorite charities and would like to gift $10,000 to each of them annually, indexed for inflation. In her will, Robinson has specified that at her death, a gift fund will be established for each charity. Given this objective, one of Robinson’s primary goals is to maintain the principal in her retirement fund in order to have a $1,000,000 gift account for each charity. Robinson recently met with her financial advisor, Brian Mitchell, CFA. During their meeting Robinson stated, “If I wanted to gamble with my investments, I would play blackjack. At least then I would have fun losing money.” Mitchell presented Robinson with three different model portfolios.
|
Asset Class |
Portfolio A |
Portfolio B |
Portfolio C |
|
Large cap U.S. stocks |
5% |
15% |
25% |
|
Small cap U.S. stocks |
5% |
|
15% |
|
International – Developed
market equities |
10% |
5% |
10% |
|
International – Emerging market equities |
15% |
|
5% |
|
U.S. Corporate bonds |
10% |
50% |
30% |
|
U.S. Treasury bonds |
5% |
20% |
|
|
Hedge fund of funds |
10% |
|
5% |
|
Venture capital |
15% |
|
|
|
Cash |
25% |
10% |
10% |
|
|
|
|
|
|
Total expected return |
6.8% |
5.5% |
7.6% |
|
Current yield |
1.4% |
1.6% |
1.8% |
Which of the portfolios would be most appropriate for Robinson?
A) Portfolio A.
B) Portfolio B.
C) Portfolio C.
Q3. James Mason is the Chief Operating Officer of the Homeless Mission Foundation (HMF), a foundation with the purpose of providing food, clothing, and shelter for homeless individuals. Mason is currently in the process of preparing a report to HMF’s board recommending an asset allocation for the pension fund. This year, Mason estimates that HMF’s operating budget will be $2.75 million. In order to assist with preparation of his report, Mason has compiled the following data.
- The market value of the foundation is currently $50,000,000.
- The cost for providing services to homeless individuals is expected to rise at a rate of 3.0% per year.
- The board would like to maintain a cash cushion equal to half of the estimated operating budget in order to meet any unexpected expenses.
- Management fees for the foundation are estimated to be 0.40%.
- The board is willing to accept market risk in order to meet its long-term objectives, but the board wants to accept shortfall risk (defined as expected return minus two standard deviations) of no more than 15%.
Mason must recommend one of three different portfolios to the board. Mason’s choice of portfolios is shown below:
|
Asset Class |
Portfolio A |
Portfolio B |
Portfolio C |
|
Large cap U.S. stocks |
24% |
30% |
20% |
|
Small cap U.S. stocks |
10% |
5% |
13% |
|
International – Developed market equities |
5% |
13% |
5% |
|
International – Emerging market equities |
5% |
5% |
10% |
|
U.S. Corporate bonds |
25% |
20% |
17% |
|
U.S. Treasury bonds |
20% |
16% |
21% |
|
Real estate |
5% |
10% |
10% |
|
Cash |
6% |
3% |
4% |
|
TOTAL |
100% |
100% |
100% |
|
Expected Annual Total Return (%) |
7.85% |
9.20% |
8.80% |
|
Expected Standard Deviation (%) |
11.15% |
12.10% |
12.20% |
In his report, Mason is going to recommend a portfolio based on 3 criteria: liquidity needs, return requirements, and shortfall risk. Which of the portfolios should Mason recommend?
A) Portfolio A.
B) Portfolio B.
C) Portfolio C. | 
发表于 2009-3-5 14:33
| 
