4% = 1% (W) + 4.5% (1-W) SOLVING FOR W = 1.065 = WEIGHT OF PORTFOL...

9.4% = 9.1% (w) + 4.5% (1-w) Solving for w = 1.065 = weight of portfolio 4 Where: Expected return on Portfolio 4 = 9.1% Expected risk-free rate = 4.5% w = optimal allocation to Portfolio 4 The optimal asset allocation for the overall portfolio is: Asset Class Weight US Equities 1.065 x 33.7 35.9% Non-US Equities 1.065 x 12.0 12.8% Long-term bonds 1.065 x 36.7 39.1% Real Estate 1.065 x 17.6 18.7% Risk free asset 1.0 – 1.065 -6.5% ii. By combining the tangency portfolio with the risk-free security, the expected risk-adjusted return (Sharpe ratio) will improve from .49 to .51. This Sharpe Ratio for this combination is higher than any other portfolio solution that meets the 9.4% return requirement. The standard deviation of this portfolio is (approximately) 9.69%. This standard deviation is lower than the 10% standard deviation of the optimal portfolio (the optimal combination of portfolio 3 and portfolio 4 with no leverage). iii. The weight of total equities in the portfolio equals 48.7% = weight of US equities + weight of Non- US equities = 35.9% + 12.8% = 48.7% PART C i. The advantages of the resampled efficient frontier approach relative to the mean-variance efficient frontier approach are: 2008 Level III Guideline Answers Morning Session – Page 15 of 40 Question: 4 Topic: Portfolio Management – Asset Allocation Minutes: 17