1. You work as an investment advisor and are considering the addition of international investments to your clients portfolio, Elizabeth Brown. You explain to Elizabeth your methodology for developing capital market expectations and determining a recommended asset allocation. In your approach to developing capital market expectations, you utilized sample statistics from the most recent 20 years of market, security, and foreign exchange price data as estimates of asset class expected returns, expected volatilities of returns, and expected correlations of returns.
2. Give two specific limitations of your approach to developing capital market expectations.

You recommend that Elizabeth consider a possible allocation of investment assets to Hong Kong real estate because prices of real estate tend to lag returns from the stock market. With the Hang Seng Index registering strong positive returns recently, you expect the wealth gains from the equity market will now be a positive factor for real estate prices.

2. Identify one problem in using historical estimates of return correlations for alternative assets such as real estate. Explain how that problem biases the formulation of expectations for real estate investments.

You show Elizabeth an Economic Research report recently published by your firm. The report contains the following conclusion: Because of recent speculative forces on the Malaysian ringgit (MYR), it is highly likely that Malaysia will impose sustained currency controls to regulate the flow of capital into the country.

3. Judge, given the likelihood that Malaysia will impose sustained currency controls, whether Elizabeth should lower, not change, or raise her expected long-term investment risk premiums. Support your response with one reason.