2008 AM exam Q 4 B-i (incorrect guideline answer?)

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sachin_patel

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This is the text of question
“The Thurlow pension plan investment policy statement (IPS) prohibits short positions and the use of leverage.”
Guideline answer:
The most appropriate asset allocation is 106.5% of investable funds to Corner portfolio 4 while borrowing 6.5% of investable funds at the risk-free rate.
The answer actually uses leverage..Am I missing something?
BTW on a side note, I took this exam and it was a killer one. I probably scored 20% in this exam.
Long way to go for me.
 
You’re pretty far back, I’m not sure what’s being referenced but it looks like the CML is recommended for a given level of return based off tangency of some efficient frontier and their specified level of acceptable risk. You might want to just focus on the more recent exams and schweser practice ones instead of taking an exam from 7 years ago and trying to find out what does and doesn’t apply, which to me seems a waste of time.
 
on top of that question, there is a part that the advisor add assumption on leverage. So nothing wrong with CFAI examiners.
 
I’ve been trapped by many of their tricks. I’d rather not make your statement. they are like us, wandering around here, my friend!
 
Miamia wrote:
on top of that question, there is a part that the advisor add assumption on leverage. So nothing wrong with CFAI examiners.
Click to expand...
You want to know that use of leverage through borrowing the risk free asset can make sense in a single-period model theoretically, as a starting point for using the Capital Allocation Line. But when advising a client you’re looking at a multi-period situation and the efficient frontier is really the best possible portfolio (versus the your minimum variance portfolio leveraged with Rf) because the risk free asset technically doesn’t exist (you know, 0 std dev from period to period) and it is impractical to think that it’s really possible, or even assume it’s possible, for an individual investor to borrow/lend at that rate from period to period.
 
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