CFA EOC Reading 13 Human capital and Asset Allocation

[cfa_novice]

CFA Book 2 EOC questions in Human capital, Asset Allocation and Insurance
Can someone explain to me why for Michael Lee (Question #3) asset allocation is 80 stock/20 bond, whereas for Tom Sampson (Question #6) asset allocation is more like 20 stock/80 bond? Thanks!

 

[Carlo]

Hi,
The two questions take a different perspective.
Overall, questions 1 to 4 refer to the case studies (page 191 onward).
Michael Lee’s question relates specifically to case study #4 (Figure 11 in the CFAI book). Here the authors link asset allocation and “correlation” between income and stock market.
In the case of Michel Lee (correlation between Michael’s income and S&P 500 = .9) there is a clear hint that we should allocate 20% to the risk-free asset (i.e. last bar on the right hand side of Figure 11).
Tom Sampson’s question is more generic and looks at someone whose HC is 100% risky. In such a scenario (HC is 100% in risky asset) which investment the Financial Adviser should recommend to Tom? The answer has to be Bonds.
In other words, in Tom’s question the focus is choosing what investment is appropriate (between risky and non-risky asset) for someone whose HC capital is entirely invested in risky asset.
Michael’s question asks in what proportion to allocate financial capital among risky and non-risky assets.
Regards, Carlo

 

[cpk123]

please refer to the same question (using search function) - this same question has been discussed on the forum multiple times. Also note that whether you like it or not - the CFAI answer is very much dependent on two “graphs” in the reading (I believe Figure 9 and Fig 12) - where they map the age of the investor to amount equity and fixed income empirically - and this question and the next use that graph almost to the letter.

 

[cfa_novice]

Thanks Carlo and cpk123!