3c.
Rebalcing strategy betweem CPPI, constant mix and buy and hold. Markets increasing, doesnt want portoflio value to decrease below 175000 and willing to accept additional risk as his portfolio value increases.
I get that they chooos CPPI for the last point that he’s willing to accept risk as value increases.
But what about the portoflio value not decreasing below 175000? Doens’t the CPPI have a dynamic Floor which can. If you want it to not decrease below 175000, i wouldb’t chose BUY AND HOLD.
Anybody? Thanks
Not sure i understand your sentence :“Doens’t the CPPI have a dynamic Floor which can.”
I assume you wanted to say that the floor value could go below 175000?
The floor is not dynamic
Let assume your floor is 175000 and the portfolio Value = 200000 , that CPPI is followed with m=1.5.
Starting portfio equity = m* (Portfolio Value - floor) =1.5 * 25000 = 37500. (=> 162500 in risk free asset)
Now if the equity falls to 17500, the portfolio must be rebalance with the same rule:
New Porfolio equity = 1.5* (new portfolio value = 162500+17500 - floor unchanged) = 1.5 * (180000 - 175000) = 7500
Your rebalance portfolio = 7500 equity and 180000-7500= 172500 in risk free asset.
You can see that when the risky part decrease in value , the portfolio converge to the floor value invested in the risk free assets, but assuming the portfolio is constantly rebalanced and the volatility of the risky asset is reasonable, there is no way to fall below the floor value
Yes CPPI has the floor value (defined by the investor) and portfolio value CAN’T reduce below this level so investor is not allowed to take further risk if it reaches the limit.
Quote the formula from Blackou "Starting portfio equity = m* (Portfolio Value - floor) "
This is the key formula to remember for CPPI - equity portion is proportion to the difference between portfolio value and floor value and the M>1.
buy and hold also has a floor, which is fixed. and the formula also applies to BH with floor value = cash amount and M=1
THanks cfa team. Great. Good luck