Imagine you are a provider of portfolio insurance. You are establishing a four-year program. The portfolio you manage is currently worth $100 million, and you promise to provide a minimum return of 0%. The equity portfolio has a standard deviation of 25% per year, and T-bills pay 5% per year. Assume for simplicity that the portfolio pays no dividends (or that all dividends are reinvested).
a. What fraction of the portfolio should be placed in bills? What fraction in equity?
b. What should the manager do if the stock portfolio falls by 3% on the first day of trading?
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