0% AND PROHIBIT THE USE OF LEVERAGE. EXHIBIT 1 PROVIDES THE RESULTS...

14.0% and prohibit the use of leverage. Exhibit 1 provides the results of a mean-variance

optimization based on annual inflation of 1.5% and a risk-free rate of 0.5%.

Exhibit 1

Wellcare Endowment Corner Portfolios

Asset Class Weights (%)

Expected

Standard

Corner

Inter-

Sharpe

Return

Domestic

Government

Corporate

Deviation

Portfolio

national

Ratio

(%)

Equity

Bonds

1 9.00 18.0 0.47 100 0 0 0

2 8.90 16.2 0.52 90 10 0 0

3 8.60 13.8 0.59 75 20 5 0

4 7.65 11.2 0.64 60 15 15 10

5 7.00 10.5 0.62 50 10 25 15

A. Recommend which two corner portfolios Darzi should use for the optimal asset

allocation to achieve the endowment’s return requirement. Determine the weights for

each of these two corner portfolios. Show your calculations.

6 minutes (Answer 4-A on page 25)

Darzi advises the board to allow the use of leverage. She proposes a strategic asset allocation

that combines the corner portfolio closest to the tangency portfolio in Exhibit 1 with borrowing

at the risk-free rate. The endowment’s annual nominal return objective remains 8.0%.

B. Calculate the optimal level of leverage to achieve the endowment’s return objective.

Show your calculations.

4 minutes (Answer 4-B on page 26)

C. Determine whether the unleveraged or leveraged strategic asset allocation offers lower

expected volatility to achieve the endowment’s return objective. Justify your response.

Note: No calculations are required.

3 minutes (Answer 4-C on page 27)

Answer Question 4-A on This Page