Asset allocation - Assignment Example

Asset Allocation (a) Bond type chosen The total bond market, Barclay Aggregate index is the bond chosen. Since the client is a household, the sub set is the High yield corporate bond. At an age of 39 years, the optimal portfolio should be in ratio of 61% stock and 39% fixed income securities. The percentage of income invested in the bond is 5% of the current salary which is the lowest and the return on the investment higher relative to other bonds in the market. The BofA Merrill Lynch US High Yield Master II Total Return Index Value© produces the best return so far in the market.

High Yield CorporateBofA Merrill Lynch US High Yield Master II Total Return Index Value©Current Salary $ 300,000.00 Value invested in Bond $ 15,000.00 Return 20 year $ 1,219.

50 Return 5 year $ 2,556.75 The return is presented based on the two maturity periods in order to know which of gives a better return in the short terror long term. High yield corporate bond- BofA Merrill Lynch US High Yield Master II Total Return Index Value has the second highest standard deviation after the US treasury. But it is attractive to household investors since corporates like banks and insurance firms will invest in the US treasury fixed income securities.(b) (i) Asset Allocation This particular allocation receives the second best return and steady coupon rate over the term of the bond.

The standard deviation of 5 year term is 8.63% while for 20 years is 8.86%, given that the minimum age of investor presented begins at 39 years old, this is the best option of getting a good coupon rate and yield in the short term if he/she chooses the 5year bond or in the long term if he /she choose the 20 year bond. This investment is however volatile due to the relatively high standard deviation. Assuming the investor bought $1000 par value bond which had maturity of 5 years, he will get 15 bond certificate each $1000(total of $15000), and the eventual return in the short term will be $2556.

75, which is greater than the 20 year term. However the investor will get fewer half year coupon payments in the 5year term relative to the 20 year term.(ii) The high yield corporate bond is positively correlated with the large and medium capital equities markets and the total bond market. That is for the 5 year period:Correlation (High yield, Large Cap) = (0.115), Correlation (High yield, mid cap) = 0.715, Correlation (High yield, Total bond) = 0.692. On the other it is negative correlated with the small equities market and the treasury bonds, that is; correlation (high yield, treasury) = -0.

467 and correlation (high yield, small cap) =-0.074.This implies that the as much as the client may be constrained with expense of mortgage payment and other household payment, the investor can still get a good return on the 5 year high yield bond and at the same time investing in the treasury bonds and shares in the medium and large stock markets. The price rises for both rises positively, if the yield on 5 year bond rises, so does the yield in the other positively correlated market in his portfolio.(iii) Portfolio risk adjusted return versus the overall marketThe risk adjusted return for the market is 4.

83%; the risk adjusted for the portfolio is 4.843% which is slightly above the market return. The portfolio has essentially outperformed the market. So it would be best if the investor bought the 5 year high yield bond.Works CitedLofthouse, Stephen. Investment Management. New York: Wiley, 2001. Print.