Hi All,
These two questions have puzzled me, have a look and kindly share your responses. Both of them are from EOC questions.
Smith is the financial advisor to Nancy Johnson and Michael Wu. Johnson is a 35-year old professor with a stable and secure annual income of $175,000. Wu is a 35-year old stockbroker with an income that averages $175,000 per annum and is highly correlated to risky asset returns. Johnson and Wu have comparable total wealth and exhibit moderate risk tolerance.
Recommend which of the following portfolio construction strategies are optimal for Johnson and Wu and justify the selections.
Allocation
Strategy A
Strategy B
Strategy C
Strategy D
Strategy E
Stocks
100%
80%
65%
20%
0%
AAA-rated government bonds
0%
20%
35%
80%
100%
My answer here was - Nancy Johnson - Strategy B or C while for Wu it was C.
Nancy - Stable secure income; Bond like human capital and therefore more of FC should be allocated to Equities. So, it has to be A, B or C. Considering moderate risk tolerance as mentioned in the question, my response was either B or C.
Official answer from the book - Strategy A; Explanation - same as mine except that the answer doesnt talk about risk tolerance at all
Wu - Human capital is risky; equity like and therefore more of FC should be allocated be allocated to bonds. Considering moderate risk tolerance and a stock broking job, answer should be C (instead of D)
Official answer - Strategy B (which is basically 80 percent equity and only 20 percent bonds)
Am i doing something wrong here ?