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Homework answers / question archive / You have been asked by a German client to recommend an asset allocation among four frontier markets: Nigeria, Pakistan, Ukraine, and Vietnam
You have been asked by a German client to recommend an asset allocation among four frontier markets: Nigeria, Pakistan, Ukraine, and Vietnam. After conducting an empirical investigation, you have concluded that Euro- denominated returns among these four countries are es- sentially uncorrelated. Sample mean returns (%/annum) and volatilities (annual standard deviations of returns) are shown below: Mean Volatility Nigeria 32% 18% Pakistan 10% 21% Ukraine -8% 16% Vietnam 13% 22% What is your estimate of minimum volatility achievable in a portfolio from these countries?
A minimum variance/volatility portfolio is a collection of securities that combine to minimize the price volatility of the overall portfolio Volatility is a statistical measure of a securities's price movements, volatility is nothing but the ups and downs in the market. Research says that higher volatility corresponds to a higher probability of declining market, while lower volatilty corresponds to a higher probablity of rising market. When it is about minimizing the risk, then it always comes to minimizing the ups and downs. Minimum volatility portfolio helps to maximize the returns and minimize the risk.
To build or create a minimum volatility/variance portfolio, it needs to stick with low volatility investments or a combination of a volatile investments with low correlation to each other. For the minimum variance portfolio, The formula is,
Mean/Volatility = returns
a. For Nigeria, given: mean = 32% and Volatility = 18%
therfore, 32/18 = 1.78% returns.
b. For Pakistan, given: mean = 10% and volatility = 21%
therefore, 10/21 = 0.47% returns.
c. For Ukraine, given: mean = -8% and Volatility = 16%
therefore, -8/16 = -0.5% returns.
d. For Vietnam, given: mean = 13% and Volatility = 22%
therefore, 13/22 = 0.6% returns.
therefore from a,b,c and d,
the returns of Nigerian country> Vietnam country> Pakistan country> Ukraine country.
The investment with the higher Sharpe Ratio wins because you’re getting the more return at lower risk.Here, we are getting more returns with Nigerian country at less risk. Here I will preffer Nigerian country to the german client for asset allocation because here the less risk is the reward for the client.
