As the chief investment officer for a money management firm specializing in taxable indi- vidual investors, you are trying to establish a strategic asset allocation for two different cli- ents. You have established that Ms. A has a risk-tolerance factor of 8, while Mr. B has a risk-tolerance factor of 27. The characteristics for four model portfolios follow:
|
|
ASSET MIX
|
|
|
Portfolio
|
Stock
|
Bond
|
ER
|
σ 2
|
|
1
|
5%
|
95%
|
8%
|
5%
|
|
2
|
25
|
75
|
9
|
10
|
|
3
|
70
|
30
|
10
|
16
|
|
4
|
90
|
10
|
11
|
25
|
a. Calculate the expected utility of each prospective portfolio for each of the two clients.
b. Which portfolio represents the optimal strategic allocation for Ms. A? Which portfolio is optimal for Mr. B? Explain why there is a difference in these two outcomes.
c. For Ms. A, what level of risk tolerance would leave her indifferent between having Portfolio 1 or Portfolio 2 as her strategic allocation? Demonstrate.