C. DETERMINE WHETHER THE UNLEVERAGED OR LEVERAGED STRATEGIC ASSET AL...

4-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.

Page 28 Level III

QUESTION 5 HAS THREE PARTS (A, B, C) FOR A TOTAL OF 13 MINUTES.

Julian Cole is a portfolio manager at Synergy, a UK-based asset management firm. He manages

a EUR 200 million portfolio for George Milton. Cole’s proprietary research has led him to

believe that the share price of Blue Creek (BLUE) will increase substantially. BLUE is currently

trading at EUR 9.75 per share. Cole wants to purchase 1,000,000 shares of BLUE for Milton’s

portfolio as quickly as possible with minimal effect on the share price. Average daily trading

volume in BLUE over the previous 10 days was 1,500,000 shares. Cole decides to use the

“advertise-to-draw-liquidity” technique for this trade execution.

A. Explain two disadvantages of Cole’s proposed technique for the BLUE trade execution.

4 minutes (Answer 5-A on page 29)

In addition to BLUE, Cole buys 3,000 shares of Livingston Homes (LIVS) for Milton’s

portfolio. LIVS trades on a quote-driven dealer market and has an average daily trading volume

of 25,000,000 shares. Cole’s order is executed in two trades as shown in Exhibit 1. He analyzes

the trading costs of the entire transaction.

Exhibit 1

LIVS Trade Data

(prices in EUR)

Bid

Trade

Ask

Size

Price

(shares)

First trade 21.07 3,000 21.13 2,500 21.13 2,000

Second trade 21.05 3,000 21.11 2,500 21.09 1,000

B. Calculate the share-volume-weighted effective spread for the LIVS transaction. Show

your calculations.

4 minutes (Answer 5-B on page 30)

Six months later, Cole discusses three potential portfolio rebalancing strategies with Milton:

buy-and-hold, constant-mix, and constant-proportion portfolio insurance (CPPI). To manage

risk, Cole rebalances Milton’s portfolio by adjusting the allocation between equities and money

market instruments. Milton is willing to invest a greater proportion of his wealth in risky assets

as his portfolio value increases. Cole believes the recent bull market has ended and the market

will be flat but oscillating. His objective is to choose the rebalancing strategy with the highest

expected return that is also consistent with Milton’s risk tolerance.

C. Determine, given Cole’s objective, the most appropriate rebalancing strategy for Milton.

Explain why the two strategies not selected are less appropriate.

5 minutes (Answer 5-C on page 31)

Answer Question 5-A on This Page