Question 14 (8 points)

Peter manages the portfolio of Mr. and Mrs. Smith, consisting of investments in real estate, stocks, bonds and commodities. They would like to change the allocation of assets in portfolio due to the volatility in markets due to Covid-19. Peter met with them for a discussion. He found that Mr. and Mrs. Smith were skeptical of the stock market and believed it will continue to decline in the future. They wanted Peter to monitor the value of stocks daily. Real estate value had also declined from $150,000 (buying price) to $115,000, but they do not want to sell for less than the buying price. The value of commodities, specifically of gold, had increased and they had a view it will increase further, so wanted to hold it.

Required:

Identify and discuss all the heuristic biases exhibited by Mr. and Mrs. Smith.

Question 12 (5 points)

Elizabeth holds a portfolio, consisting of $30 million invested in stock market and $20 million invested in bonds. Return and risk data has been given below.

	Return	Risk
Stocks	15%	20%
Bonds	8%	10%

Required:

1. If correlation between returns of stocks and bonds is 0.65, calculate portfolio risk.
2. Assuming returns are normally distributed, calculate portfolio VaR at 95% confidence interval.

Formulae:

Portfolio VaR= 1.65 x _p x portfolio value