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Extreme Events – Specimen Question A.5.1

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You are an asset allocator selecting between five different asset categories A1 to A5 using mean-variance optimisation. Your expected future returns, standard deviations of returns and correlations for the asset categories are as follows:

 

 

 

 

Expected correlation coefficients

 

Expected return (%pa)

Expected standard deviation (%pa)

A1

A2

A3

A4

A5

A1

3.0

2

1

 

 

 

 

A2

5.0

4

0.4

1

 

 

 

A3

6.0

8

-0.6

-0.5

1

 

 

A4

7.0

14

0.0

-0.4

0.2

1

 

A5

7.5

15

-0.4

-0.4

0.6

0.3

1

 

(a)    Plot the efficient frontier and the asset mixes making up the points along the efficient frontier, assuming that risk-free is to be equated with zero volatility of return and that no non-negative holdings are allowed for any asset category.

 

Answer/Hints

 

(b)   Show how the efficient frontier and the asset mixes making up the points along the efficient frontier would alter if risk-free is equated with 50% in Asset A1 and 50% in Asset A2.

 

Answer/Hints

 

(c)    In what circumstances might a mixed minimum risk portfolio as per (b) apply? Give examples of the types of asset that might then be A1 and A2.

 

Answer/Hints

 


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