Investment Theory

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Assignment 4

Due Monday October 11

HBS Case: Harvard Management Company

The objective of studying this case is to understand the concepts of diversification and the efficient frontier by analyzing Harvard Management Company’s application of portfolio theory for managing the endowment of Harvard University. Please read the case carefully and be prepared to discuss the following questions in class on Monday, October 11.

• What is the role and importance of Harvard's endowment? • What is Harvard's Policy Portfolio? How is this portfolio determined? • How does HMC develop its capital market assumptions? What is the US equity premium implied in HMC's capital market assumptions? • Why did HMC constrain the portfolio weights in their mean-variance analysis? • What was the reason for giving HMC a minimum and maximum range for each asset class?

1. Using the capital market assumptions made by the HMC (given in Exhibit 11 of the case), complete the Assignment 4 Excel file posted on Yscec. 2. After completing the Excel assignment, provide clear and precise answers to the questions on the following pages.

You should submit the printouts of the completed Excel spreadsheet (Part 1 – Part 4) and this file stapled together in the beginning of class on Monday, October 11. You should also have a copy of the printouts as reference for class discussion.

Note: Please type your answers. You should provide quantitative (and/or qualitative) justification for all your answers, i.e., do not just give the answer but explain clearly and concisely how you arrived at the answer. You may refer to the results in the Excel assignment in answering the questions below.

Q1. Suppose you want to invest $100,000 in cash, domestic equity, and domestic bonds. Your preference is captured well by the following utility function with the degree of risk aversion A = 7:


What is your optimal asset allocation decision, i.e., how should you...
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