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Problem: Minimising
Downside Risk - Purchasing and maintaining a portfolio of assets so as to minimise the
risk of losing value.
An obvious objective and common strategy in
investing is to minimise the risk of losing ground. What'sBest can help you to accomplish
this.
You're considering investing in three different assets. You need to determine how much to
invest in each of three assets to minimise the risk of having to sell off your baseball
cards.
You have forecasts for the expected return of each asset under seven equally likely
scenarios - there is a transportation strike, interest rates rise or fall, crops
fail, Cubs win world series, Bulls win NBA finals, etc. You know that if you invest 100%
of your capital in Asset 2, the average return under all possible scenarios (your expected
return) is 19.9%.
You plan to live on the return from your portfolio. After figuring your living expenses,
you find that a return below 11% will force you to start selling off your beloved baseball
card collection to live in the manner to which you've become accustomed. Call that 11%
your threshold return.
The return on Asset 2 is below your threshold return of 11% in a couple of scenarios, and
under Scenario 7 you actually lose money on your portfolio - perhaps forcing you to
sell the entire baseball card collection. While the 19.9% return is very appealing, the
thought of parting with even some of your baseball cards is frightening. You've decided
you would like an average or expected return of at least 13% (call this your desired
return), but you want to minimise the likelihood that you'll have to sell off some of
those valuable cards.
The objective is to invest for a profit while minimising the risk of diminishing your
baseball card collection.
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