Hartej Chanrai is a consultant to the board of directors of Vrieland Foundation. The board asks
Chanrai to recommend an asset allocation for Vrieland. Chanrai reviews the current Vrieland
investment policy statement, key aspects of which are shown in Exhibit 1.
Exhibit 1
Vrieland Foundation
Key Aspects of Investment Policy Statement
Return objective:
The required rate of return on the investment portfolio is 9.5 percent.
Risk objectives:
1. Diversify the portfolio consistent with prudent investment practices.
2. A maximum standard deviation of portfolio returns of 10.6 percent is
acceptable.
Constraint:
Liquidity is needed to fund the annual contribution to the operating budget.
(There are no other relevant constraints.)
For the strategic asset allocation analysis, Chanrai has generated the corner portfolios shown in
Exhibit 2.
Exhibit 2
Corner Portfolios
(Risk-free Rate = 4.0%)
Asset Classes (Portfolio Weights, %)
Corner
Portfolio
Number
Expected
Return
(%)
Expected
Standard
Deviation
(%)
Sharpe
Ratio U.S.
Equities
Non-
U.S.
Equities
Longterm
U.S.
Bonds
Intermediateterm
U.S.
Bonds
Non-
U.S.
Bonds
Real
Estate
1 10.8 16.1 0.42 100.0 0.0 0.0 0.0 0.0 0.0
2 10.4 14.2 0.45 82.4 0.0 0.0 0.0 0.0 17.6
3 10.3 13.6 0.46 74.1 4.0 0.0 0.0 0.0 21.9
4 9.1 9.1 0.55 33.7 12.0 36.7 0.0 0.0 17.6
5 8.9 8.7 0.56 31.4 12.0 26.7 13.0 0.0 16.9
6 8.5 7.4 0.60 25.0 11.8 0.0 45.3 3.4 14.5
7 7.3 5.2 0.62 0.0 13.7 0.0 53.0 27.1 6.2
8 7.2 5.1 0.61 0.0 11.2 0.0 53.0 31.5 4.3
2006
Page 48
Answer Parts A, B, and C using mean-variance analysis:
A.
Selectthe
twoadjacent corner portfolios to be used in finding the
mostappropriate
strategic asset allocation for Vrieland’s investment portfolio, assuming that the purchase
of securities using borrowed money (margin) is not allowed.
(3 minutes)
B.
Determinethe
mostappropriate strategic asset allocation between the two adjacent
corner portfolios selected in Part A, assuming that the purchase of securities using
borrowed money (margin) is not allowed.
(3 minutes)
C.
Determinethe percentage amount of the
mostappropriate strategic asset allocation
(determined in Part B) that should be invested in U.S. equities.