2010 Essay Question 8 Part A

[Zoey]

Can someone please explain the answer to this question to me? It is a rebalancing problem and the case states that corridor widths are set at +/- 10% of the target allocation. The UK Fixed Income target weight is 40% and the closing allocation is 45%. The answer states that since this is outside the corridor, the portfolio would be rebalanced to target weights using percentage of portfolio rebalancing.
My question here is how in the world does CFAI think that 45% weight in UK Fixed Income is outside the target range based on a 10% corridor. To me, it would have to be either at 39% or 51% to be outside the target range (ie 40% plus or minus 10%).
… any comments on why either I’m seeing this wrong or they are?

 

[cpk123]

nope it is relative..
40 +/- 10%(40) = 36 to 44%
READ THE TEXT CAREFULLY IN THE VIGNETTE – SAYS -> with tolerance bands or corridor widths set at ± 10% of the target allocation.

 

[Paracoda81]

I remember that they were asking whether the current allocation for the International equities should be re-balance or not .After I calculated the CORRIDOR width ,it appeared to still be within the CORRIDOR .However they said in the answer that since the Fixed Income is out of range , the International equities should be re-balance !!
My question here , does rebalance any of the portfolio assets classes trigger a rebalance for the whole portfolio ?I

 

[S666]

Yeah i remember getting this one wrong for that reason… The equities were still within the band, but fixed income was not.
The thing is, thinking about it… You cannot rebalance one without rebalancing the others by definition as you only have 100% to play with. If you add a % to one, it has to be taken from another.

 

[Zoey]

cpk123 wrote:
nope it is relative..
40 +/- 10%(40) = 36 to 44%
READ THE TEXT CAREFULLY IN THE VIGNETTE – SAYS -> with tolerance bands or corridor widths set at ± 10% of the target allocation.

See I fell into the trap! good call thank you. Lets say that there is a question like this with a table. the table has three columns: asset class, target allocation, and corridor. U.S. Equities target allocation is 15% and the corridor says “+/-5%”. In my hypothetical, it says nothing about “of the target allocation” or anything else that would indicate relativity. Would you then assume that the corridors are additive/subtractive?
I’m wondering if it is ALWAYS supposed to be a relative multiplication calculation.

 

[Warren Buffett]

Wait, I don’t even think that part of the answer is relevant anyway, is it? On 1 April the portfolio would be rebalanced in both cases, right?

 

[Zoey]

Warren what are you talking about?

 

[ltj]

He’s talking about the ultimate result. PPR and Calendar rebalancing result in the same international equity allocation as of 1 April.
To understand this, you have to know that UK FI breaks the tolerance and triggers a full portfolio rebal back to target, so of course it’s relevant. You would have to do the PPR math for each asset before answering.