CFAI 2015 READING 18 EOC 18

[tobymen]

The question is to recommend an alternative portfolio for board consideation. May I seek your help to explain the rationale for choosing portfolio E. is it just because of the lowest surplus volatility? Personally I feel that portoflio F is more sutiable as it can achieve the highest return with slight decrease in surplus volatility. Thanks in advance.

 

[Carlo]

I completely agree with you…
And I suspect most people out there are on our side as well.
Still the only correct choice is E and we would be utterly and irremediably wrong if we put down anything which is not E.
The only thing that matters, here as with anything related to the CFA exam, is what the question says and, to quote, this question says, “Anticipating the board’s desire to avoid a repetition of last year’s shrinkage in the surplus,…”
In absence of a more clearly stated objective (and that one is the only one I can find), this ‘avoiding to repeat a surplus shrinkage’ becomes our one and only guiding light, the lens through which we look at the world.
It doesn’t even matter if the board really wants to avoid the surplus shrinkage. The only thing that matters is that the question says that Giselle is anticipating that the board wish to avoid shrinkage.
What you and I “Personally feel”, to quote part of your remark above, is, from an exam standpoint, not only irrelevant but the first step down a slippery slope.
Good luck, Carlo

 

[OMGMileyCyrus]

As mentioned in the previous post, the “board’s desire to avoid a repetition of last year’s shrinkage in the surplus” sets the tone for how we answer this question. To avoid a shrinkage in surplus, one must (a) ensure that the level of total return does not drop below the current portfolio’s expected annual return, and (b) minimize surplus volatility compared to surplus volatility in the current portfolio.
Portfolio F satisfies both (a) and (b) above, increasing the expected annual return from 9.0% to 10.2% and reducing the surplus volatility from 8.0% to 7.5%. Although Portfolio E accomplishes the same results as Portfolio F, the main difference between the two portfolios is that Portfolio E further reduces surplus volatility to a level below that of Portfolio F. I think the focus here is not so much on the increase in expected annual return (which is a valid argument for choosing Portfolio F), but on the decrease in surplus volatility (evident in Portfolio E) that makes Portfolio E the best recommendation.