 # 2008 Essay- Asset Allocatio: Arithmetic or Geometric

Question 4: Asset Allocation, section A(i) Does anyone calculate the required return in geometric way? this will lead to required return of 9.46% and a 30/70 allocation between corner portfolio 3 and 4 respectively, the risk objective will be 10.18% more than the allowed risk of 10% and fail to be the appropriate combination. CFAI guideline answer using Arithmetic to calculate required return (=8.7%+0.7%=9.4%) resulting in a 25/75 allocation and it is a different story. So, I wonder if you use geometric way as in the above does CFAI accept all the consequent calculations and judgements based on it???

Doesn’t matter dude. If you get a question on corner portfolios, they aren’t trying to ask if you know the difference between arithmetic and geometric return.

It does matter in this question. If you use the geometric, or “correct” method, the standard deviation criteria is busted. It was a bad drafting of the question by CFAI.

rule that i use, if asked in essay question, give both if asked in vignette, give geometric

just calculate geometric on everything…dont use arithmetic at all and dont risk it…anw geometric is more correct

superstar123 Wrote: ------------------------------------------------------- > just calculate geometric on everything…dont use > arithmetic at all and dont risk it…anw geometric > is more correct You say that yet the 2008 exam used arithmetic. Who is more correct, you or CFA?

Need to use arithmetic because it says plus. This question screwed me up as well as using geometric placed standard deviation above the limit. It was a truly conflicting question to the text.

I use plus whenever there is a separate management fee, which often happens in endowment/foundation questions as well.

Paraguay , I hear you. I got this one wrong/confused for exactly the same reason and I posted ( vented ) in another thread . The answer seems to be : There is AN answer , so if it doesn’t make sense , try it another way. If you use Geometric then there is NO combination portfolio at all which will match both return and stdev. So iterate. Go back to your question , scratch your head a bit, then say , aha! let me try arithmetic. Things will fall in place after that ( answer to two problems found !)

jana - that is why i was annoyed, but ok with it. It is a ridiculous contradiction, but common sense will tell you to go the other direction and add. Where my concern would be is if it was essay, but then, i would think they would count both.

doesn’t work here. This question and the next would generate WRONG answers if you try geometric , even in essay

I sat for the 2008 exam - passed - and this f’ing question caused me to lose at least 15 minutes and a bunch of sanity. It put me behind schedule for the rest of the morning.

nice of you to pop in and check on us , frisian

http://www.analystforum.com/phorums/read.php?13,1249359,1249365#msg-1249365 refers to my previous answer: I saw earn return 8.7 PLUS fee 0.7, so I added the fees. anyway, I am thinking if fees are based on beginning value of portfolio for each return (yearly) period, the req. return and fees should be just added. if the fees are based on final value (incl. return) compounding should be used.

yes , and which mutual fund charges their management fees on the prior-period-NAV values? Not one

yes of course you are right, it should be some average value of portfolio over the period.

When dealing with this question, i myself kept continuing with geometric way with required return of 9.46%, SD = 10.18% and an allocation of 30/70 (instead of 9.4%, 10% and 25/75 respectively if using arithmetic). And I explained that though the SD=10.18% is a little bit above the max allowed 10% but is acceptable because the result of 10.18% is actually overstated when we assume perfect correlation in calculating it. Do you think that’s acceptable by CFAI?

No