Extreme Events – Specimen Question A.5.1
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Question and Answer Summary
You are an asset allocator selecting between five different
asset categories A1 to A5 using meanvariance 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 riskfree is to be equated with zero volatility of
return and that no nonnegative 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 riskfree 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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