Restricted Frontier the Unrestricted Frontier the Individual

¶ … Restricted Frontier

The Unrestricted Frontier

The Individual of Five Assets, Equally Weighted Portfolio, Efficient Frontier and CAL

Did you observe any differences between the restricted and unrestricted efficient frontier developed using your portfolio? Why?

Using my portfolio, I did observe differences between the restricted and unrestricted efficient frontier. For example, the restricted frontier has been pulled up on the chart and greatly affected by Australian bonds, as well as the accessibility of cash, to a point where the curve appears to be unequal. This means that the unrestricted efficient frontier, affected by bank accepted-bills, is not "pulling its equal weight," so to speak (Bodi 2011). This means that there is an imbalance in the economic performance of cash flow in New Zealand. Given the current economic situations, this is not necessarily a surprise, and more of an expectations. I would assume that as the economy begins to even out, so will the equality of the curve on my graph. However, the curve is currently uneven, which can be seen as reflection of the uneven state of the economy.

Using your graph, discuss the concept of the Markowitz Portfolio Theory and the CAPM. Clearly show that using a risk-free asset, you are able to obtain a higher return for a given risk.

(a) Describe each of the asset classes, setting out their characteristics and risks.

According to the Markowitz Portfolio Theory, we will see a pull between AM and GM measures as well as the restricted and unrestricted frontier. There will be a push-pull scenario in both situations. Therefore, the characteristics and risks present in the concepts graphed above are highly affected by the economy. For instance, the portfolio developed reflects on Australian and International bonds, cash in the economy, property values, and bank-accepted bills. Obviously, the economic situation affects each of these concepts, and the reflection can be seen in the graph plotted below. There is a general relationship between these two concepts and they work in an intertwined relationship.

b. Graph

GM Yield

Bonds Property Australian shares International shares

1983

4.9

15.67

1.7

1 / 5

1984

3.8

22.45%

1.2

1.2

1985

3.2

15.79%

.6

.6

1986

2.3

15.13%

.9

.9

1987

1.9

17.39%

1.2

1.2

1988

1.8

1.4

1.4

1989

2

11.11%

2.2

2

1990

2

1.1

1.2

1991

2

1.4

.6

1992

2.6

.9

.9

1993

2.5

2.3

2.2

1994

2.3

1.1

1.2

1995

2.3

1.2

.6

1996

2.6

1.9

.9

1997

2.8

2

1.2

1998

2.9

1.4

1.4

1999

3.1

1.8

1.1

2000

3.6

1.1

1.2

2001

4.2

1.1

1.2

2002

4.1

1.1

1.2

2003

4.1

1.3

.6

AM Yield

Bonds Property Australian shares International shares

1983

4.9

15.67

1.7

1 / 5

1984

4.8

22.45%

1.2

1.2

1985

3.2

15.79%

.6

.6

1986

2.3

11.13%

.9

.9

1987

1.9

12.39%

3.2

1.2

1988

1.8

3.4

1.4

1989

2

11.11%

2.2

2.2

1990

2

1.1

1.2

1991

2

1.4

.6

1992

2.6

.9

.9

1993

2.5

.6

.7

1994

2.3

1.1

1.2

1995

2.3

1.2

.6

1996

2.6

1.9

.9

1997

2.8

2

1.2

1998

2.9

1.4

1.4

1999

3.1

.5

1.5

2000

3.6

1.1

1.2

2001

4.2

3

.5

2002

4.1

1.1

1.2

2003

4.1

1.3

.6

(c) What would be the main problems you would encounter if you tried using the efficient frontier you have identified for portfolio selection purposes?

Using the efficient frontier, one of the major problems I see is the issue of variance. It is difficult to get a solid result from the usage of the efficient frontier only, especially with the current economic trends. This has become more apparent to me by plotting the actual graphs. I expect that I would not get a complete and accurate result by plotting a graph using the efficient frontier only. It is important, therefore, to plot other information, as completed above, to get more accurate and reliable results. This does not meen that the efficient frontier cannot provide decent or useful information; it just needs to be used for specific points and purposes.

(d) How does foreign exchange risk contribute to the risk of international investments? Is it worthwhile to hedge exchange rate risk?

The foreign exchange risk, reflected in my graphs above with the international concepts taken into consideration, contributes to the risk of the overall economic issues present at hand. The international economy is so globalized that if one major producing country has a problem with production and output, it can affect all of the world. It certainly affects other countries. Therefore, international investments are not necessarily secure, simply because of this factor. It is worthwhile, as a result, to hedge exchange risk rates because these rates can give us an estimate of whether or not it is wise to invest internationally. Anything that can give one some kind of prediction or helpful comment in this economy is always good. An estimate or prediction can assist one with making future decisions and figuring out whether or not it is useful to proceed with different decisions and concepts.

(e) During a world financial crisis, all the major financial markets will usually move in the similar direction (i.e. become highly correlated). Do you think this will limit the benefits of international diversification?

I believe so, and I believe this is also a result of globalization as well. Globalization has brought cultures together and seems to be creating and meshing concepts and ideas together. This is certainly true of growing technology, bringing the world together and thus crushing together markets that were otherwise diversified. With this increased togetherness, we see less variance overall, and therefore less international diversification. As the economy suffers, there is a greater feeling of togetherness between countries assisting each other and an even greater reliance on globalization. As a result, we have even less variance and less diversification. We see that technology is, in fact, the major contributor to this phenomenon. For instance, the fact that we are able to reach out to each other across countries and time zones with the click of a mouse through an instant message or an easily sent Email means that we are therefore becoming more and more intermeshed. This is certain to wipe out not only human diversification, but market diversification as well. Increasingly, as the economy affects more and more individuals, there is a greater feeling of needing to pull together in order to overcome this issue. This "togetherness" type feeling is affecting the overall market trends by reducing the variety of the market and investments available to individuals. This is also occurring because of things like corporate mergers, where more and more companies seem to be coming together in order to make themselves stronger in their market, but again, this also means there is less diversification of the market. While a merger can easily save one company or both involved by helping to boost their overall production and value, as well as making them larger and stronger as a whole, we can see how two companies coming together as one can only reduce the concepts of diversification at hand (Taylor 2010).

(f) It is often said that Australian investors have an inefficient home bias in their asset portfolios. What does this mean? Why is it important? What are the principal causes of "home bias"?