THROUGH 48 RELATE TO MONITOR AND REBALANCING GEORGE PENA...

Questions 43 through 48 relate to Monitor and Rebalancing George Pena Case Scenario George Pena, CFA, is a portfolio manager at Aqua Wealth Management (AWM), LLC. Pena has extensive experience with managing private wealth accounts. Karen Lawrence and Joseph Smith are Pena’s newest clients. With respect to each client’s portfolio, Pena has a task on hand. Task A: Determine the optimal rebalancing strategy for Lawrence’s portfolio. Task B: Determine the optimal corridor width for each asset class in Smith’s portfolio. Task A: Optimal Rebalancing Strategy Lawrence has recently inherited $300,000 from her deceased father’s estate. She is 35 years old and practices dentistry privately. Last year, Lawrence’s house was destroyed in a domestic fire. 15% of the inheritance amount as well as insurance claims have enabled her to seek new accommodation. Despite the incident, her living expenses are being comfortably met. During a meeting with Lawrence, she shares with Pena her desire to maintain a minimum cash balance during economic downturns. However, she would like to maximize portfolio returns when the opportunity arises and is willing to utilize her cash balance to increase equity exposure. Upon the conclusion of their meeting, Pena collects data from several economic reports each of which forecast a sustained upward trend in equity markets. Pena estimates that Lawrence’s stocks will generate a return of 5%. Her portfolio value and stock/cash allocation, prior to any changes, is $2 million and 55/45, respectively. Lewis Wise is an intern at AWM. He is being trained by Pena and is assisting him in the management of Lawrence’s portfolio. During his training session, he asks the following questions: Question 1: The graphical representations of the constant proportion portfolio insurance (CPPI) and constant-mix strategies are mirror images of each other. Is this true? Question 2: Is it correct to state that the buy-and-hold strategy is consistent with a risk tolerance which has a positive relation to wealth at all levels of stock return? Task B: Optimal Corridor Width For this task, Pena compiles volatility, return, transaction cost, and correlation data on the three asset classes held in Smith’s (Exhibit 1) portfolio. Exhibit 1 Expected Return, Volatility, Transaction Cost, and Correlation Data Volatility Expected Transaction (Annualized Asset Class Return Costs Correlation with the rest of the portfolio Standard (Annualized) Deviation) Domestic Equity 12.5% 14.2% 0.20% 0.25 Domestic Bonds 7.8 11.8 0.45 0.18 Commodities 11.3 11.9 0.19 0.09 Mildred Jones, CFA, is AWM’s Human Resource Manager. She has recently implemented a policy which mandates firing any underperforming managers. Some managers have complained that the policy is too stringent and has resulted in the company losing promising managers which have underperformed due to uncontrollable external factors. 43. Considering economic forecasts and Lawrence’s requirements, which of the following rebalancing strategies is most appropriate for Lawrence’s portfolio? A. CPPI B. Buy-and-hold C. Constant-mix 44. Assuming expectations are realized, Lawrence’s revised stock/cash allocation under a buy-and-hold strategy is closest to: A. 53.5/46.5 B. 55.0/45.0 45. The most appropriate responses to Wise’s questions are: Question 1 Question 2 A. No No B. No Yes C. Yes No 46. Based only on the transaction cost and volatility information presented in Exhibit 1, which asset classes will have the narrowest corridor width? A. Commodities B. Domestic bonds C. Domestic equity 47. Considering the correlation data in isolation, Pena will conclude that the asset class with the narrowest corridor width is: 48. Jones’ policy characterizes a (n): A. Type I error. B. Type II error. C. adequate manager continuation policy.