Tracking Portfolio- Example Consider three securities whose expected returns and factor sensitivities are given by: rA = 0.45...

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Finance

Tracking Portfolio- Example
Consider three securities whose expected returns and factorsensitivities are given by:
rA = 0.45 + 1.5F1 ? 4F2 + ?A
rB = 0.05 + 3F1 + 2F2 + ?B
rC = 0.08 + 1.2F1 + 0F2 + ?C
Suppose we wish to construct a tracking portfolio with ?1 = 1.8and ?2 = 1.
Determine the proportion to be invested in each security.
Simultaneous Equations
xA + xB + xC = 1
1.5xA + 3xB + 1.2xC = 1.8
?4xA + 2xB + 0 = 1
solution: xA = ?0.08; xB = 0.35; xC = 0.73
Could you please explain what is happening in this example. Idon't understand what the point of this is and what they aresolving for and how they are getting the first simultaneousequation.

Answer & Explanation Solved by verified expert

3.7 Ratings (657 Votes)

Assume you are investing in three securities If Total amount invested is say 100 million and 20 million is invested in Security A 30 million in B and 50million in C XAWeight of Security A in the portfolio2010002 XBWeight of Security B in the portfolio3010003 XCWeight of Security A in the portfolio5010005 See Answer

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Tracking Portfolio- ExampleConsider three securities whose expected returns and factorsensitivities are given by:rA = 0.45 + 1.5F1 ? 4F2 + ?ArB = 0.05 + 3F1 + 2F2 + ?BrC = 0.08 + 1.2F1 + 0F2 + ?CSuppose we wish to construct a tracking portfolio with ?1 = 1.8and ?2 = 1.Determine the proportion to be invested in each security.Simultaneous EquationsxA + xB + xC = 11.5xA + 3xB + 1.2xC = 1.8?4xA + 2xB + 0 = 1solution: xA = ?0.08; xB = 0.35; xC = 0.73Could you please explain what is happening in this example. Idon't understand what the point of this is and what they aresolving for and how they are getting the first simultaneousequation.