Michael Lee is a 35-year old equity trader with an average annual income of $200,000. Lee’s income exhibits a 0.90 correlation to the performance of the S&P 500. Recommend which of the following portfolio construction strategies are opti- mal for Hernandez and Lee and justify the selections. solution, 80% to stocks and 20% to AAA rated govt bonds I thought it should be more skewed towards AAA gov’t bonds. i.e., atleast 35% AAA bonds. (option C) Any clue??
I have similar queestions as well. (p424 Q2, Q3)
- in Q2, Michael WU’s income is also ‘highly correlated’ with risky asset returns, yet the answer is 35% on AAA govt. bond, vs Q3 Lee’s 20% on AAA govt. bond --> what makes the difference between these two?
given the weight difference (35%, 20%), Wu’s income correlation with risky asset returns should be even ‘higher’ than Lee’s 0.9.
- is the percentage in each Strategy with respect to ‘total capital (wealth)’ or ‘financial capital’?
>>assuming it’s w.r.t. ‘fiancial capital’
if we follow the rule ‘100 - age’ % of equity (age = 35, 65% of equity), and take human capital into account,
for someone whose human capital (H) is stock-like (i.e. risky asset), financial capital (F) - stock & risk-free(RF)
RF/(H+F) = 35% -> RF/F = (H+F)*35% / F > 35%
without exact amount of H and F, there is no way to calculate weight of risk-free assets (i.e. AAA govt. bond)
>> assuming it’s w.r.t ‘total capital’
if we follow the rule ‘100 - age’ % of equity (age = 35, 65% of equity), we get 35% for Wu in Q2, but we still don’t know why the answer is 20% for Lee in Q3.
bump…
bump
guys - please make sense of these questions after looking at the two graphs (figures 9 and 12) in the book and then looking at the asset allocation in that same context. that is what has been done.
it is not the best answer that should be given, but it is what it is.