Hi there, I was just wondering, for this question that has already been answered

Question

Hi there, I was just wondering, for this question that has already been answered:

Liam is 28 years old and saving toward his retirement in 35 years. In his RRSP he owns 1,000 shares of Royal Bank of Canada valued at $98 each and $125,000 principal value of 4.5% Government of Canada 20-year bonds. The bonds trade at a premium of 30%. Liam wishes to sell his investments and purchase a mutual fund. Part A: What is Liam’s asset allocation? Is it appropriate, and why?

How did you calculate that Liam is investing 44% to equity, and 56% to bonds?

Explanation / Answer

I thin the answer that you quote is incorrect. The answer seems to be based on book value of bonds ($125,000). {Equity = (98 * 1000)/(98*1000 + 125,000) = 43.9%; Hence, debt = 56.1%}

But, the asset allocation is always calculated on the basis of market value.

Market Value of Equity = $98 * 1000 = $98,000

Market Value of Debt - $125,000 * (1 + 30%) {Trading at 30% premium, mentioned in question}, = $162,500

Weight of Equity = $98,000/($98,000 + $162,500) = 37.62%

Weight of debt = $162,500/($98,000 + $162,500) = 62.38%

Given his age, Liam's portfolio seems more conservative, given he is saving towards his retirement (and hence has a long term investment period). Given his age and term of investment, he should instead opt for an aggressive portfolio, which is weighted more towards equity. This would help his capital grow over a longer period of term.

Portfolio weighted in bonds is good for a person who has short term of investment or who requires regular income (in form of coupons) - i.e., someone who is aged near to 45-50 years.

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