Reading 13 practice problem 3 says: Lee is a 35 year old equity trader with an average income of 200k. His income exhibits 0.9 correlation to performance of S&P. Which portfolio is optimal for him. A B C Strategy Stocks 80 65 20 Bonds 20 35 80 But the answer says: B is optimal.A higher correlation between HC and stock market results in less diversification and higher risk for the total portfolio. Lee’s allocation to stocks is higher than might be expected given the correlation between his income and the S&P because of behavioural factors. He is an equity trader and is likely to believe he knows stocks and to have a relative high degree of risk tolerance. I thought that since his HC is equity like given correlation we would invest more in bonds?
This question is harsh. He’s clearly someone with the ability and willingness to take risk, yet his human capital is so equity like his FC should be bond like.
I guess the take home point here is be sensible. A 80% bond portfolio for a working 35yr old is far too high.
I remember getting that wrong when I was going through the EOCs
Agreed. This was a pain of a question and one that I got wrong too.
I think we need to ensure that we always arrive back at the 70/30 mix of equities and bonds, but be sensible…because an 80% allocation to bond is ridics when you actually think about it.