April 2019 Q3

[mabikwa]

Hello ActEd Team,

I would like to seek some guidance regarding this question.

The solution in the ASET approaches the problem from an active portfolio management / MPT perspective, where expected return and risk are calculated for each office/ product combination. The approach then uses an efficient frontier to determine the optimal mix of business.

My attempt was slightly different. I thought about using the model to determine total economic capital, and then allocating this capital to each office using the Euler allocation principle, based on marginal contributions to risk. This would allow WidgetCo to calculate RAROC for each office and use this information to guide strategic decisions about which areas of the business should grow / contract.

Would this approach still be considered valid in the exam? Or would marks mainly be awarded for discussing MPT / efficient frontiers, as suggested in the ASET solution?

If both approaches are acceptable, would the MPT approach generally be preferred, given the potential practical challenges associated with applying the Euler principle in this context?

Many thanks.

 

[Alvin Kissoon]

Hi,

Thanks for the question!

Looking at the Examiners Report solution, it is suggesting an approach where return and risk is being considered. The solutions also talk about designing an 'ideal' portfolio and considering return v risk, which is consistent with an MPT approach. However, you are also providing an approach involving return and risk, by considering RAROC and capital allocation, so you should gain credit.

What I would suggest you do is look at the Examiners Report and compare your solution to it - each sub-sentence and/or bullet would be likely to have scored half a mark.

I hope this helps, please let me know if there are any followups!

Alvin.

 

[mabikwa]

Hi Alvin,

Thanks, that’s very helpful.

I appreciate the guidance.

Brighton