Assignment 6: Asset Allocation Scenario
THE ASSIGNMENT
Worth 50 points.
You are provided with capital market assumptions for thirteen asset classes. See Assignment_6 spreadsheet in Blackboard. Your starting portfolio is 60% US Large Cap Equities and 40% US Investment Grade Debt. The portfolio has an expected return of 4.75% and an expected volatility (annual standard deviation of returns) of 10.5%.
1) Show your calculations in the spreadsheet. Alternatively, you can show your math in the Word document.
a. Expected return of 4.75%
b. Volatility of 10.5%
2) You want to diversify your portfolio and reduce your portfolio risk. Select four(4) asset classes that will help you achieve your two portfolio goals, namely 6.5% expected return and a volatility less than 10.5%. State your reasoning. Given two reasons for each asset class.
a. Asset Class 1: two reasons
b. Asset Class 2: two reasons
c. Asset Class 3: two reasons
d. Asset Class 4: two reasons
Remember to specify each asset class (the name). The potential reasons are return, volatility, and correlation.
Remember, the four asset classes will be used to reduce the allocation to US large cap equities below 60% and the allocation to US investment grade debt to below 40%.
Remember, you must have at least one asset class with higher return and one with lower volatility. Otherwise, you will end up with higher portfolio return and higher portfolio volatility OR lower portfolio return. We want the portfolio return to be at least 6.5% (higher is OK) but we want lower portfolio volatility. In other words, we want an efficient or optimal portfolio.
3) State why the Fake asset class is impossible (in other words, why is it a unicorn).
4) If you were worried about taxes, which asset class would you add? Explain.
5) If you were worried about inflation (and interest rates rising), which asset class would you add? Explain.
6) If you were worried about a recession (and interest rates falling), which asset class would you add? Explain.
7) If you were worried about the US dollar depreciating, which asset class would you add? Explain.
8) Extra Credit: What happens to the correlation between US equities and US investment grade debt, Including US Treasury bonds, if we are entering a new economic regime of high and rising inflation, after a few decades of low and stable inflation? Explain.