QUESTION 2 HAS TWO PARTS (A， B) FOR A TOTAL OF 7 MINUTES.

 

　　Louise and Christopher Maclin are considering the rebalancing implications of two possible strategic asset allocation scenarios. Grant Webb outlines a rebalancing methodology that sets upper and lower limits for the weights of each asset class based on the same fixed percentage bands for each asset class. The portfolio will be rebalanced to the target allocations whenever the weight of an asset class violates the fixed percentage limits. Webb also describes an alternate rebalancing methodology， based on standard deviation， in which each asset class is rebalanced when the weight for the asset class exceeds the number of standard deviations set for all asset classes.

 

　　A. Discuss why a rebalancing methodology based on fixed percentage bands may result in excessive transaction costs in each of the following strategic asset allocation scenarios：

 

　　i. The Maclins hold a small allocation (less than 5 percent) to an emerging market equities fund

 

　　ii. The Maclins hold a sizable allocation to a hedge fund that has experienced a persistently very low correlation with the other assets in the portfolio

 

　　(4 minutes)

 

　　Webb is concerned about the negative effect of realized capital gains on the Maclins‘ portfolio.

 

　　B. Determine， given Webb’s concern about realized capital gains， whether a rebalancing methodology based on standard deviation is likely to be more or less appropriate than a rebalancing methodology based on fixed percentage bands. Justify your response with one reason.

 

　　(3 minutes)