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Re-balancing Strategies (Buy and Hold (Value (Unlimited upside, Value…
Re-balancing Strategies
CFA Notes
S16 R32
Diagrams
Exposure Diagram = Risk Tolerance
Payoff
Buy and Hold
Do nothing strategy
Best in trending markets
Linearly related to stock value
Function of portfolio in stocks
Value
Unlimited upside
Value never fall below allocation to bills
Risk Tolerance
Zero if Port Value falls to allocation to bills
Diagrams
Payoff
Slope = allocation to stocks
Can't fall below allocation to bills
Exposure
Slope = 1 (LINEAR)
Cross X axis at allocation to Bills
m = 1 (LINEAR)
Constant Mix
Do Something Strategy
Best for range bound markets
Greater the volatility the better off
Little downside protection if any
Poor in trending up markets
Diagrams
Payoff
Concave
volitility impacts exact shape
Rep "sale of portfolio insurance"
Exposure
Slope = allocation to stocks
Cross X axis at 0
Portfolio can fall to ZERO
continue to buy stock as they fall
m < 1 (CONCAVE)
CPPI (Constant Proportion Port Insurance)
Formula
$ in Stock = m (Assets - Floor)
m = 2, Value $100, Floor $75
$ = 2 (100 - 75)
$50 in Stock
50/50 Portfolio
$25 = cushion
can't fall below this unless markets fall below this without action
CPPI is B&H with m =1
Risk Tolerance
Increase more quickly above the floor
ZERO tolerance to risk below floor
m > 1 (CONVEX)
Convex
rep "purchase of portfolio insurance"
Diagram
Payoff
Convex
Exposure
Slope > 1
Cross X axis at Floor
Sell when stock fall , buy when they raise
Good downside protection
Perform well in up markets
Option Based (OPPI)
Start with
specified time horizon
Floor value
= PV of floor value at end of TH
