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    Quizfebruary 27 Solutions

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    Sherstobitov Sergei
    The pension fund is considering three institutional investors for allocation: a stock investor, bond investor, and money market manager. The stock investor has an expected return of 20% and standard deviation of 30%. The bond investor has an expected return of 12% and standard deviation of 15%. The money market manager has an expected return of 8% and no standard deviation. The pension fund requires a 24% return. Constructing a portfolio with just stocks and bonds, the appropriate proportions are 1.5 times investment in stocks and selling short 0.5 times the total funds in bonds. This portfolio has an expected return of 24% and standard deviation of 44.87%. If borrowing was allowed at the risk-free 8%

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    Quizfebruary 27 Solutions

    Uploaded by

    Sherstobitov Sergei
    24 views2 pages
    The pension fund is considering three institutional investors for allocation: a stock investor, bond investor, and money market manager. The stock investor has an expected return of 20% and standard deviation of 30%. The bond investor has an expected return of 12% and standard deviation of 15%. The money market manager has an expected return of 8% and no standard deviation. The pension fund requires a 24% return. Constructing a portfolio with just stocks and bonds, the appropriate proportions are 1.5 times investment in stocks and selling short 0.5 times the total funds in bonds. This portfolio has an expected return of 24% and standard deviation of 44.87%. If borrowing was allowed at the risk-free 8%

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    The pension fund is considering three institutional investors for allocation: a stock investor, bond investor, and money market manager. The stock investor has an expected return of 20% and standard deviation of 30%. The bond investor has an expected return of 12% and standard deviation of 15%. The money market manager has an expected return of 8% and no standard deviation. The pension fund requires a 24% return. Constructing a portfolio with just stocks and bonds, the appropriate proportions are 1.5 times investment in stocks and selling short 0.5 times the total funds in bonds. This portfolio has an expected return of 24% and standard deviation of 44.87%. If borrowing was allowed at the risk-free 8%

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    24 views2 pages

    Quizfebruary 27 Solutions

    Uploaded by

    Sherstobitov Sergei
    The pension fund is considering three institutional investors for allocation: a stock investor, bond investor, and money market manager. The stock investor has an expected return of 20% and standard deviation of 30%. The bond investor has an expected return of 12% and standard deviation of 15%. The money market manager has an expected return of 8% and no standard deviation. The pension fund requires a 24% return. Constructing a portfolio with just stocks and bonds, the appropriate proportions are 1.5 times investment in stocks and selling short 0.5 times the total funds in bonds. This portfolio has an expected return of 24% and standard deviation of 44.87%. If borrowing was allowed at the risk-free 8%

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 2

    Quiz For Lecture # 7

    You are consultant for a pension fund. The pension fund is allocating money and
    considers three institutional investors. The first is a stock investor, the second a long-term
    government and corporate bond investor, the third is a money market manager.

    In your function as the consultant you have done your homework and figured out the
    following track records:

    expected return standard deviation


    Stock investor 20%


    30%

    Bond investor 12%


    15%

    Money market manager 8%


    -

    The pension fund requires 24% return to meet its asset/liability-objectives. The guidelines
    do not allow borrowing, however you can sell short. You wish to construct a portfolio of
    only stocks and bonds with an expected return of 24%

    What are the appropriate portfolio proportions and the resulting standard deviations?

    What reduction in standard deviation could you attain if you were allowed to borrow at
    the risk free rate of 8%?

    BKM ch. 8, p. 241 # 8

    Graph

    Point Q is the stock/bond combination with mean = 24%. Let ws be the proportion of
    stocks and 1 - ws be the proportion of bonds required to achieve the 24% mean, then:

    24% = 20 x ws + 12 x (1-ws) = 12 + 8ws

    ws = 1.50
    1- ws = -0.50

    Therefore you would have to sell short an amount of bonds equal to 0.50 of your total
    funds, invest 1.50 times your total funds in stocks. The standard deviation of this
    portfolio would be:

    σQ = [1.502 x 900 + (-0.50)2 x 225 +2 x (1.50) x (-0.50) x 45]0.50 = 44.87%


    If you were allowed to borrow at the risk free rate of 8%, the way to chaieve the target
    expected return of 24% would be to invest more than 100% of your funds in the optimal
    risky portfolio, moving out along the CAL, to the rifht of P, up to R, on the graph.
    R is the point on the optimal CAL which has the mean of 24%. Using the formula for the
    optimal CAL we can find the corresponding standard deviation:

    E(rc) = 8 + 0.4601 σc = 24

    Setting E(rc) = 24 we get σc = 34.78%, which is considerably less than 44.78%

    Graph

    What is the portfolio composition of point R on the optimal CAL? The mean of any
    portfolio along this CAL is:

    Where y is the proportion invested in the optimal risky portfolio P and rP is the mean of
    that portfolio, which is 15.61%

    24 = 8 + y(15.61 – 8)
    y = 2.1025

    This means that for every $1 of your own funds invested in portfolio p, you would
    borrow an additional $ 1.1025 and invest it also in portfolio P.

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