# CPPI - Constant Proportion Portfolio Strategy (Need Help To Understand Forumula)

Can someone explain how this formula works? Target Investments in Stocks = m x (Portfolio Value - Floor Value) where m = a fixed constant. If: (1) m = 3 for example, (its held constant based on some # picked by the investor) - or is 0<=m<=1? (In the book it says if M> 1 then CPPI is called CPPI Insurance. (2) We know the portfolio value = \$100k for example (Stocks + Bonds) so Target Investment in Stocks = 3 x (\$100k - FLoor Value) How do you calculation Target Investment in Stocks if you do not know the floor value? If we set the floor value to \$40k (held in Tbills for example) then Stocks would have to be \$180- but in this case, total market value is only \$100 for the portfolio. It seems to be a circular reference… Im sure that this is so simple, but I think Im missing a key point…

I think if the persons portfolio of stocks drop below 180, then they put the remainder in stocks.

With CPPI, the floor value is not what is invested in T-bills. It’s the min desired value of your portfolio. In your example, you’ll be leveraged: long \$180 in stocks and short \$80 in Tbills.

Ahh - what threw me was the Buy and Hold that held the \$40 in Tbills an \$60 in Stocks and called the \$40 the floor (where buy and hold would flux around this floor based on the movement in the equity). Need to turn that off in my head and rethink this… Im working though Volkovv’s example from the begining of the month that I just found… http://www.analystforum.com/phorums/read.php?13,684130,698130#msg-698130 The Floor could be any arbitrary # - its the lowest I would want my portfolio to drop to (per fsa).

if you use 40 as floor and say M=2, then you would do (100-4) X2 = 120% in Stocks, so looks like you will need to borrow…I dont know if you HAVE to invest a portion in the Floor, in other words I dont know if you need to invest the Floor, \$40, in Rf assets or not for CPPI.

^^^ You don’t. You’ll borrow \$20 and invest \$120 in stocks. You’ll trust on constant/frequent monitoring and rebalancing to ensure that you don’t drop below the floor value. Without that and considering the levered nature of your portfolio(higher ‘m’ means higher leverage), you can be in deep sh!t.

I thought in the above example, it would work like this: If CPPI = 2 x (S - Floor) = 2 x (100 - 40) = 80, then you would invest 80 in stocks, unless the value dropped below 40, at which point you would invest 100% in cash (non-stocks). That’s why BH is the same, but with m = 1 and floor = cash. Is this right?

per Bigs comments above - here is what it looks like in a spreadsheet. (the format is a little funky but you get the drift…) (OOPS REVISED SINCE I CHANGED FROM m-1.5 to M=2) m = 2 Floor = 40 Portfolio Floor Equity Tbills Comment 200 40 320 -120 Need to Borrow to maintain Mix 190 40 300 -110 Need to Borrow to maintain Mix 180 40 280 -100 Need to Borrow to maintain Mix 170 40 260 -90 Need to Borrow to maintain Mix 160 40 240 -80 Need to Borrow to maintain Mix 150 40 220 -70 Need to Borrow to maintain Mix 140 40 200 -60 Need to Borrow to maintain Mix 130 40 180 -50 Need to Borrow to maintain Mix 120 40 160 -40 Need to Borrow to maintain Mix 110 40 140 -30 Need to Borrow to maintain Mix 100 40 120 -20 Need to Borrow to maintain Mix 90 40 100 -10 Need to Borrow to maintain Mix 80 40 80 0 100% Equities 70 40 60 10 60 40 40 20 50 40 20 30 40 40 0 40 30 40 0 30 20 40 0 20 10 40 0 10 0 40 0 0

you don’t; all the floor really tells you is when the portfolio drops to \$40 (using your numbers 2 * (40-40) = 0) meaning you are completelly out of stocks, and fully invested in T-bills, since value T-bills = Portfolio - value of stocks; hence you make sure that you never drop below \$40 when the value of portfolio is above \$40, the value in risk-free asset may be low (and in extreme cases you may even borrow)

Where is striker??

striker, striker come in, striker, stiker do you read me…I think we’ve lost striker. Striker One is down, I repeat Striker One is down…

Watch striker get 100% on the exam…!!

sorry - went out for a round of golf to clear my mind - but it looks like you guys covered it well and got to the point of this by the end. looks like the first few posts may have been off, but i think DATA monkey hit on it good… I would add in if M<1 then its a constant mix (contrarian portfolio), M=1 it s abuy and hold, and M>1 its CPPI…