You are an investment advisor to a wealthy Swiss family who wish to extend their exposure...

Transcribed Image Text:

You are an investment advisor to a wealthy Swiss family who wish to extend their exposure to stocks traded abroad. You use a model of the Swiss asset market that has a factor structure with two factors, fi and f2, both with zero mean. Factor 1 represents returns on domestic Swiss investment, factor 2 represents returns on international investment (including any currency conversions). Your clients have access to three assets: the risk- free bond G with rate rc = 4 (per cent), and two well-diversified funds K and N with returns T = 6+2.5f₁ +0.5/2 = 7+1f₁ +2fai (in per cent). The factors have standard deviations of o₁ = 5, 0₂ = 8 and a correlation of P12 = ¹/5. In light of your discussions with your client, you find that your client desires an investment style where her exposure to factor fa is three times as large as their exposure to factor fi: b₂/b₁ = 3. Their target rate of return is 8 (per cent). (a) Solve your client's investment problem and provide them with a simple, non- technical summary of the main features of the recommended portfolio. (b) After you have given your clients your portfolio recommendation, the family consult with another advisor, who recommends the portfolio w = 0.3269; ₂ = 0.6731 and who tells them that his portfolio "is more efficient" than your recommendation. How do you respond to this claim? You are an investment advisor to a wealthy Swiss family who wish to extend their exposure to stocks traded abroad. You use a model of the Swiss asset market that has a factor structure with two factors, fi and f2, both with zero mean. Factor 1 represents returns on domestic Swiss investment, factor 2 represents returns on international investment (including any currency conversions). Your clients have access to three assets: the risk- free bond G with rate rc = 4 (per cent), and two well-diversified funds K and N with returns T = 6+2.5f₁ +0.5/2 = 7+1f₁ +2fai (in per cent). The factors have standard deviations of o₁ = 5, 0₂ = 8 and a correlation of P12 = ¹/5. In light of your discussions with your client, you find that your client desires an investment style where her exposure to factor fa is three times as large as their exposure to factor fi: b₂/b₁ = 3. Their target rate of return is 8 (per cent). (a) Solve your client's investment problem and provide them with a simple, non- technical summary of the main features of the recommended portfolio. (b) After you have given your clients your portfolio recommendation, the family consult with another advisor, who recommends the portfolio w = 0.3269; ₂ = 0.6731 and who tells them that his portfolio "is more efficient" than your recommendation. How do you respond to this claim?

Answer rating: 100% (QA)

a To solve the clients investment problem we need to find the optimal weights for the two funds K an... View the full answer