True or False: Safety-First Measure

CFA Level III
#1

True or False: If the minimum acceptable return is less than the risk-free rate when considering Safety-First, the optimal minimum acceptable return should be the risk-free rate.

#2

I’m thinking it is false.

#3

False

#4

Correct. It is optimal to be invested in a risk-free asset if the MAR is below RFR.

#5

True

#6

Pimp In What authoritative source did you see this answer? This answer does have a bit of a perverse CFA style logic (this after they have shown you lots of safety first examples where MAR is less than risk free - like I dont want to lose more than 2% of portfolio in any given year) I dont know that it would necessarily be true - suppose that you were seeking the opportunity for a return higher than risk free and the risk characteristics of the opportunity also gave you adequate comfort that you can meet MAR. In this case the investor does not want to settle for risk free?1?

#7

JohnyMac Wrote: ------------------------------------------------------- > I dont know that it would necessarily be true - > suppose that you were seeking the opportunity for > a return higher than risk free and the risk > characteristics of the opportunity also gave you > adequate comfort that you can meet MAR. In this > case the investor does not want to settle for risk > free?1? Your question does not relate to Roy’s Safety First ratio. RSF gives you a ratio indicating your relative probability of meeting your minimum goal. For the ratio you should use the higher of either the risk free rate or the minimum acceptable return in the calculation. For example, if the risk free rate is 3%, and your minimum goal is 5%, for Roy’s Safety First you should use the 5% number in your calculation. Example 1: Return(expected) = 11% Minimum Acceptable Return = 5% Standard Deviation = 8% Risk Free Rate = 3% Roy’s Safety First Ratio = (11-5)/8 = .75 For an example of what pimp is alluding to, if the risk free rate is 3%, and your minimum goal is 1%, for RSF you should use the 3% number in your calculation. Example 2: Return(expected) = 11% Minimum Acceptable Return = 1% Standard Deviation = 8% Risk Free Rate = 3% Roy’s Safety First Ratio = (11-3)/8 = 1

#8

wow. I had no idea about this.

#9

Good catch. See CFAI V3-pg 227.

#10

Dwight - Would it be possible to have a negative or lower than RFR minimum acceptable return for the Sortino Ratio? The name ‘Roy’s Safety First’ is so cheezy.

#11

Dwight Dont know if I buy that - Minimum acceptable return is just that - if I am looking to compare portfolios for the purpose of identifying the one that gives me the best chance of meeting that MAR overriding the MAC with the “optimal risk free rate” is not answering the central question posed by safety first

#12

I thought that if an investor does not want to lose more than a certain amount then we put a negative number for MAR. This wouldn’t hold true if we always had to put rf if our minimum acceptable was negative.

#13

Schweser practice exam Vol 1, Exam 1 question 1C The RFR= 2%, MAR = -2% when asked to calculate RSF, -2% is used

#14

So doesn’t mean that pimp’s answer to that true/false question is wrong?

#15

Schweser is saying that you use the MAR regardless of the RFR (as pointed out in the above example). Can anyone prove schwesers answer wrong?

#16

See CFAI, Vol 3, Pg 227.

#17

You guys are reading this wrong in my opinion. CFAI p. 227 says the IF the MAR is below the Rf rate then you should INVEST in the Rf as it will produce the highest RSF ratio. It doesn’t say you should use the Rf as the MAR.

#18

Thanks mwvt for coming to the rescue here

#19

patkeenan Wrote: ------------------------------------------------------- > Schweser is saying that you use the MAR regardless > of the RFR (as pointed out in the above example). > Can anyone prove schwesers answer wrong? This example didn’t give you the Rf as a portfolio option. Edit: crossed posts with you pk. I don’t think either contradicts each other.

#20

mwvt9 Wrote: ------------------------------------------------------- > You guys are reading this wrong in my opinion. > > CFAI p. 227 says the IF the MAR is below the Rf > rate then you should INVEST in the Rf as it will > produce the highest RSF ratio. > > It doesn’t say you should use the Rf as the MAR. Got - thanks. Sorry for the confusion all.