55.0 = (53.2)(0.25)
+(55.6)(0.725)
+(55.6)(0.75)
Part B
Corner Portfolio 5 and the risk-free portfolio should be included in the new strategic asset
allocation, because some combination of the two portfolios will be mean-variance superior to
any other combination of different portfolios that also satisfy the director’s revised return
requirement and risk tolerance.
The Corner 5 portfolio is the tangency portfolio (the highest-Sharpe-ratio efficient portfolio at
0.284). Combinations of the tangency portfolio (expected return = 8.00%) and the risk-free
portfolio (expected return = 4.00%) that place at least a 50% weight on the tangency portfolio
will satisfy the director’s return requirement [(8% × 0.50) + (4% × 0.50) = 6%] and will lie on
the Capital Allocation Line (CAL). Portfolios on the CAL provide the lowest level of risk for a
given level of expected return (or highest expected return for a given level of risk). Among the
portfolios satisfying the director’s return requirement, some—including the 50/50 portfolio mix
of Corner Portfolio 5 and the risk-free portfolio—will also be consistent with the director’s
specified risk tolerance. (For example, the standard deviation of the 50/50 portfolio is 7.05% =
(0.5)(14.1), well below the new constraint of 12%). Lourie would choose from among these
latter portfolios for the new strategic asset allocation.
LEVEL III, QUESTION 4
Topic: Portfolio Performance Measurement
Minutes: 10
Reading Assignments:
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