A finished FIN-655 Topic 3 constrained frontier memo example, pricing a leverage ban in added volatility, an exclusion in tracking error and an illiquidity cap against unsmoothed risk. Searches like "fin 655 topic 3 assignment example", "fin655 topic 3 sample" and "fin-655 topic 3 example" land here.
What a finished FIN-655 Topic 3 constrained frontier memo looks like
Illustrative capital market inputs set the problem. With cash at 3.0 percent, the highest-Sharpe mix on the case's frontier expects 6.5 percent at 10 percent volatility, a ratio of 0.35. Reaching the 7.5 percent target from there means holding about 129 percent of that mix and borrowing the rest, at volatility near 12.9. Borrowing is forbidden, so the memo moves up the frontier instead, to an equity-heavier mix expecting 7.5 at 13.5 volatility. The leverage ban therefore costs about 0.6 points of volatility at the target. The industry exclusion, about 4 percent of the benchmark, is priced as roughly 0.5 percent of tracking error rather than as a forecast return loss. The private equity inputs are then corrected: appraisal-based returns report 12 percent volatility, and unsmoothed they show about 22.
How a FIN-655 Topic 3 example is structured
The memo is arranged as the unconstrained answer followed by one constraint at a time. It opens with the foundation's target, its spending commitments and the three rules its governing documents impose. The theory passage draws the frontier, the line from cash through the highest-Sharpe mix, and why that line requires borrowing above the mix's return. Each constraint gets a section with the same three parts: what the rule forbids, what the optimal portfolio does once the rule binds, and what the difference costs in a stated unit. The leverage section adds a passage on Fischer Black's argument that restricted borrowing pushes investors toward high-beta holdings. The illiquidity section explains why smoothed appraisal returns flatter private assets and shows the cap binding only on the flattering inputs. The memo closes by ranking the three costs and defending the recommended mix against the alternative of lowering the target.
The unconstrained answer stated first
Holding about 129 percent of the highest-Sharpe mix, funded by borrowing, reaches 7.5 percent at volatility near 12.9, the reference point every constrained portfolio is measured against.
A leverage ban priced in volatility
Without borrowing, the target needs an equity-heavier mix at 13.5 percent volatility, so the rule costs about 0.6 points of risk for the same expected return.
An exclusion priced in tracking error
Removing an industry worth about 4 percent of the benchmark adds roughly 0.5 percent of tracking error, and the memo declines to forecast whether that helps or hurts.
Smoothed returns corrected before optimizing
Appraisal-based private equity returns show 12 percent volatility, about 22 once unsmoothed, and only the flattering figure makes the 15 percent illiquidity cap bind.
Lowering the target, weighed and rejected
Holding the unlevered highest-Sharpe mix would cut expected return by a full point, which the memo prices as smaller grants rather than as lower risk.
Where marks go in FIN-655 Topic 3
An optimizer's output presented as the recommendation, with the foundation's rules applied afterward or not at all, draws the deepest deduction, because the topic is about the distance between the two. Papers that list the constraints without pricing any of them leave the board unable to tell which rule is expensive. Treating the exclusion as a certain loss of return asserts a forecast the evidence does not settle; tracking error is the cost that can be stated. Feeding appraisal-based returns into the optimizer unadjusted lets smoothing masquerade as diversification and fills the portfolio with illiquid assets. Recommending borrowing that the governing documents forbid proposes a portfolio the committee has no authority to hold. A memo that never weighs lowering the target against accepting more volatility has skipped the one trade the board actually has to make.
Get a FIN-655 Topic 3 example written to your instructions
Send the FIN-655 Topic 3 instructions and the rubric shared in your classroom, with the inputs and constraints your section's case supplies. We write a custom example to them, with the unconstrained answer stated, each constraint priced in its own unit, smoothed returns corrected and the recommended mix defended against a lower target, in 24 to 48 hours. The first one is free.
FIN-655 Topic 3 questions, answered
Why does the textbook solution require borrowing?
Because the best risk-adjusted mix on the frontier expects less than the target. Portfolio theory says any investor should hold that mix combined with cash, lending to take less risk and borrowing to take more. An investor needing 7.5 percent from a mix expecting 6.5 must borrow to scale it up. When borrowing is forbidden, the next best choice is a riskier mix higher on the frontier, which carries a lower Sharpe ratio.
What does unsmoothing do to private asset returns?
Appraisal-based valuations change slowly, so reported returns look steadier and less correlated with public markets than the underlying assets are. Unsmoothing methods estimate the underlying volatility by removing that lag from the return series. In the example, private equity's reported 12 percent volatility becomes about 22 once corrected, which shrinks the weight an optimizer would give it and changes whether the illiquidity cap matters at all.
Is the memo's mix suitable for a real foundation?
The memo cannot say. Its return and volatility inputs, the target, the exclusion's size and the private equity figures are all illustrative, chosen so that each constraint's cost appears separately. A real foundation's portfolio depends on its own governing documents, spending policy, grant commitments and the capital market assumptions its consultant documents. The memo demonstrates constrained portfolio reasoning for FIN-655 and makes no recommendation about any real fund.