Question

A portfolio has a market value of S1 million. The initial portfolio value and the portfolio value after one quarter are shown in the following table. Date Portfolio value Money market instruments Stocks Jan 1 $1,000,000 $300,000 $700,000 Mar 31 $1,040,000 $300,000 $740,000 The money market instruments earn no interest. Required: Suppose the investment policy statement requires a target asset allocation of 70% in stocks and 30% in money market instruments. The portfolio manager begins to reallocate the funds between stocks and money market (a) (7 marks) instruments Determine the dollar amounts and directions of stocks and money market instruments moved. (b) After portfolio rebalancing in (a), the portfolio manager changes the asset (13 marks) allocation strategy to a constant proportion portfolio insurance (CPPI) strategy and the risk parameter is 2. On Jun 30, the value of the stocks has risen 15% over the previous quarter and the manager begins to move S61,200 from the money market account to the stock market. Determine the required floor value of portfolio.

Answer 1

(a) As of 31 March: Value of stocks = $740,000 and Value of money market = $300,000

After rebalancing of portfolio by 70:30 (70% equity and 30% money market instrument

New Stock portfolio = 70% * (740,000 +300,000) = $728,000

New money market portfolio = 30% * (740,000 +300,000) = $312,000

Based on the above we see -$12,000 (728,000-740,000) was taken out by the portfolio manager and the same +$12,000 was added in Money market instrument.

(b)

On 30-June Value of equity increased by +15% to = (1+15%) * 728,000 = $837,200

Total portfolio value as on 30-June = 837,200 + 312,000 = 1,149,200

Under constant proportion portfolio insurance (CPPI) and risk parameter 2, portfolio manager reallocated $61,200 from money market instruments to stock market.

Amount to be reallocated to stock market (risky assets) = multiplier * (portfolio value - floor value of portfolio)

  61,200 = 2* (1,149,200 - floor value)

Floor value = 1,149,200 - 161200/2

Floor value of portfolio = $1,068,600