Propose and justify an asset allocation for the Sanchezes, given the information about possible market scenarios provided below (30 points)

It is now three years later. The portfolio is worth $12 million. Mr. Sanchez has decided to join a privately held international investment group specializing in global mineral extraction. He is now contemplating investing $5 million for a royalty interest in an Australian oil field. He expects that his return on this investment will approximate $1.5 million annually for 10 year. There is no information on the riskiness of the royalty payments.

c)Can the existing investment policy accommodate such an investment? If not, how should the policy be modified? Propose changes regarding risk, rate of return and constraints. (20 points)

d)What, if any, asset allocation revision would you recommend, if Mr. Sanchez makes the investment and if the expected royalty level materializes?

\begin{tabular}{lccc} & Expected Annual Total Return & Expected Annual Yield & Expected Annual Standard Deviation \\ \hline Low growth, low inflation & & & \\ 60\% probability) & & & \\ Cash equivalents & 5% & 5% & 3% \\ Domestic bonds & 11 & 8 & 15 \\ Domestic stocks & 15 & 3 & 22 \\ [nternational stocks & 11 & 2 & 25 \\ Equity real estate & 8 & 7 & 2 \\ Precious metals & 0 & 0 & 12 \\ Rapid growth, high inflation & & & \\ 20\% probability) & & & \\ Cash equivalents & 10 & 10 & 3 \\ Domestic bonds & 12 & 12 & 17 \\ Domestic stocks & 8 & 4 & 20 \\ (nternational stocks & 16 & 3 & 22 \\ Equity real estate & 14 & 7 & 7 \\ Precious metals & 20 & 0 & 15 \\ Depression/deflation & & & \\ (20\% probability) & & & \\ Cash equivalents & 2 & 2 & 3 \\ Domestic bonds & 15 & 6 & 13 \\ Domestic stocks & 12 & 1 & 24 \\ (nternational stocks & 14 & 1.5 & 27 \\ Equity real estate & 0 & 0 & 7 \\ Precious metals & 5 & 0 & 12 \end{tabular} \begin{tabular}{lccc} & Expected Annual Total Return & Expected Annual Yield & Expected Annual Standard Deviation \\ \hline Low growth, low inflation & & & \\ 60\% probability) & & & \\ Cash equivalents & 5% & 5% & 3% \\ Domestic bonds & 11 & 8 & 15 \\ Domestic stocks & 15 & 3 & 22 \\ [nternational stocks & 11 & 2 & 25 \\ Equity real estate & 8 & 7 & 2 \\ Precious metals & 0 & 0 & 12 \\ Rapid growth, high inflation & & & \\ 20\% probability) & & & \\ Cash equivalents & 10 & 10 & 3 \\ Domestic bonds & 12 & 12 & 17 \\ Domestic stocks & 8 & 4 & 20 \\ (nternational stocks & 16 & 3 & 22 \\ Equity real estate & 14 & 7 & 7 \\ Precious metals & 20 & 0 & 15 \\ Depression/deflation & & & \\ (20\% probability) & & & \\ Cash equivalents & 2 & 2 & 3 \\ Domestic bonds & 15 & 6 & 13 \\ Domestic stocks & 12 & 1 & 24 \\ (nternational stocks & 14 & 1.5 & 27 \\ Equity real estate & 0 & 0 & 7 \\ Precious metals & 5 & 0 & 12 \end{tabular}