CASE SOLUTION We have 2 options of portfolio allocation based on criteria mentioned below: Option1: Optimal Portfolio based on Tangent portfolio and Efficiency Frontier
CASE SOLUTION
We have 2 options of portfolio allocation based on criteria mentioned below:
Option1: Optimal Portfolio based on Tangent portfolio and Efficiency Frontier
Option2: Range of Optimal Portfolios based on a predetermined return goal and probability
Option1: Optimal Portfolio based on Tangent portfolio and Efficiency Frontier
* The available asset mix consisted of Stocks, Government T bonds, Short Term Securities and Corporate Bonds. Government T bonds are assumed to be the risk free asset. Even though the standard deviation is 11% we are assuming them to be risk free for the sake of calculating the efficiency frontier.
* We calculate the optimal asset allocation under the assumption that we do not have any floor restrictions on the expected return and then evaluate the probability of losing more than the restricted 5%
* We chose various expected target returns and obtained corresponding minimum variance.
* The reward to variability ratio, which is the slope of the Capital Allocation Line combining T bills and the minimum variance portfolio, was calculated. The maximum reward to variability ratio represents the point of tangency with the portfolio set. This tangency portfolio is the optimal risk portfolio. (Check appendix for efficient frontier)
* Optimal Asset Allocation:
STD
ER
S (Reward-to-Variability)
2.67%
1.00%
0.2368
Weights
Stocks
50.89%
T Bonds
0.00%
S.T. Sec
0.59%
C.Bonds
48.52%
* The optimal risk portfolio has an expected return of 11%. However the minimum downside that is acceptable is a loss of 5%. With this portfolio mix, the probability that the investment will lose excess of 5% is 10.33% [=NORMSDIST{(-5 - 11.0)/12.67}].
We have 2 options of portfolio allocation based on criteria mentioned below:
Option1: Optimal Portfolio based on Tangent portfolio and Efficiency Frontier
Option2: Range of Optimal Portfolios based on a predetermined return goal and probability
Option1: Optimal Portfolio based on Tangent portfolio and Efficiency Frontier
* The available asset mix consisted of Stocks, Government T bonds, Short Term Securities and Corporate Bonds. Government T bonds are assumed to be the risk free asset. Even though the standard deviation is 11% we are assuming them to be risk free for the sake of calculating the efficiency frontier.
* We calculate the optimal asset allocation under the assumption that we do not have any floor restrictions on the expected return and then evaluate the probability of losing more than the restricted 5%
* We chose various expected target returns and obtained corresponding minimum variance.
* The reward to variability ratio, which is the slope of the Capital Allocation Line combining T bills and the minimum variance portfolio, was calculated. The maximum reward to variability ratio represents the point of tangency with the portfolio set. This tangency portfolio is the optimal risk portfolio. (Check appendix for efficient frontier)
* Optimal Asset Allocation:
STD
ER
S (Reward-to-Variability)
2.67%
1.00%
0.2368
Weights
Stocks
50.89%
T Bonds
0.00%
S.T. Sec
0.59%
C.Bonds
48.52%
* The optimal risk portfolio has an expected return of 11%. However the minimum downside that is acceptable is a loss of 5%. With this portfolio mix, the probability that the investment will lose excess of 5% is 10.33% [=NORMSDIST{(-5 - 11.0)/12.67}].
