Reading 19 Section 4 Prob-wtd return vs Exp. return

CFA Level III Portfolio Management
#1

To illustrate, assume that a portfolio associated with a goal has an expected return of 7% with 10% expected volatility and the investor has indicated that the goal is to be met over the next five years with at least 90% confidence. Over the next five years, that portfolio is expected to produce returns of 35% with a volatility of 22.4%.25 In short, this portfolio is expected to experience an average compound return of only 1.3% per year over five years with a probability of 90%; this result is quite a bit lower than the portfolio’s average 7% expected return (see Exhibit 34).

Does anyone know how the reading is calculating this 1.3% number? I don’t really understand the section & what the reading is trying to get at

#2

They probably did a Monte Carlo simulation.

#3

The 1.3% is not shown how they calculate it, but it is likely a monte carlo type of calculation to come up with probabilities. Look at Exhint 36 which shows numbers.

#4

You calculate it this way: Mean in 5 years is 35%. 90% of a normal distribution with SD of 22.4% is 50% (complete right side of the curve) + 40% of the left side of the curve (80% that is 1,282 SD that is 35% - 22.4% x 1,282 = 6,83 in 5 years => 1,2566% in a year

#5

Just gonna need you to write those all down on paper :joy:

Edit: sorry that was a bit snarky, not intended, y’all on point