Expected Utility Function

CFA Level III Portfolio Management
#1

Hi All,

Again CFAI is out to confuse the readers in the text.

The utility function is as follows:

Um = E (Rm) - 0.005(Ra) (Variance m)

*Need to be aware the formula is already putting the .005 into percentage form. If the reader puts the expected market return and standard deviation into decimal form i.e. 7% = 0.07 this will generate the wrong answer for the reader.

If you put everything in decimal form, which 99% of the material you should the the formula should be the following:

Um = E(Rm) - .05(Ra)(Variance m)

Thanks.

#2

Um = E(Rm) - 0.5 (Ra)(Variance m) if decimal form is used.

#3

i have also seen Ua=ra - lumda A * Variance A

whats the difference?

#4

They are just two different formulas, have to use the context of the question to answer.

#5

any insight?

#6

That is for the utillity of Active Manager returns…forget the section, maybe AA or Evaluation of Performance.

#7

0.05 is for asset allocation, without 0.05 is for portfolio manager

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#8

It under managing a group of managers, its just a risk function. They would have to give the variables on the test.

#9

What book? Just went through AA and Perform don’t see it. Found it. Equity - Portfolio managment. Jeesh this thing was hard to find.

#10

Its in Book 4 page 214

#11

Thanks this is helpful. If you put everything in decimal form (i.e. 7% = 0.07), the formula should be:

Um = E(Rm) - 0.5(Ra)(Variance m)

Don’t ask me why.

PS. Tomorrow is exam day. Where else would I have got the answer if not from AF.