Stephen Maddrey, CFA, has been hired to develop an investment policy statement and strategic
asset allocation for the $3.25 million portfolio of Alan Thornhill. Prior to their first meeting,
Thornhill sends Maddrey the e-mail shown in Exhibit 1.
Exhibit 1
Thornhill’s E-mail
To: Stephen Maddrey, CFA
From: Alan Thornhill
I am excited to be working with you. I would like you to invest my funds in asset classes
chosen from the following comprehensive list of permissible asset classes:
•Money market instruments
•U.S. balanced fund
•Nominal U.S. corporate bonds
•Nominal U.S. government bonds
•S&P 500 Index fund
I do not want to use short-selling in my portfolio.
Thank you.
Maddrey believes Thornhill has made several fundamental errors in specifying the asset classes
for his portfolio. In addition, Maddrey recommends inflation-protected bonds be considered
because they constitute a separate asset class distinct from nominal bonds. In support of his
statement, Maddrey prepares Exhibit 2.
Exhibit 2
Expected Correlation of Returns for Selected Asset Classes
Asset Class
Nominal U.S.
Corporate
Bonds
Nominal U.S.
Government
Bonds
Inflationprotected
Bonds
Nominal U.S. corporate bonds 1.00 --- ---
Nominal U.S. government bonds 0.85 1.00 ---
Inflation-protected bonds 0.71 0.80 1.00
A.
SupportMaddrey’s recommendation with
tworeasons.
(4 minutes)
B.
Describe
twofundamental errors in Thornhill’s specification of asset classes for his
portfolio.
(4 minutes)
Level III
Maddrey is developing a strategic asset allocation for Thornhill. Maddrey has experience
conducting mean-variance optimization using unadjusted historical mean returns, variances, and
covariances. He is considering integrating the Black-Litterman approach into the asset allocation
process.
C.
Describehow integrating the Black-Litterman approach into the asset allocation process
would affect the:
i. specification of expected return inputs.
ii. level of market diversification of the resulting portfolio.
ss=MsoNormal style='margin-bottom:0in;margin-bottom:.0001pt;line-height: normal;mso-layout-grid-align:none;text-autospace:none'>Ingrams’ current asset allocation.
C.
Identify, based on the Ingrams’ IPS,
threeother problems in the current asset allocation.
Support
eachof your responses with
onereason.