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Table of Contents

0. Executive Summary
1. Return Calculations and Sample Statistics
2. Value-at-Risk (VaR) Calculations
3. Rolling Analysis
4. Portfolio Theory
5. Asset Allocation

























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0. Executive Summary
0.1 Description of Assets
Vanguard 500 Index Investor (VFINX):
The Vanguard 500 Index Investor tracks the performance of the S&P 500 index. The
mutual funds is mainly composed of the assets in the S&P 500 index, which contains a
high proportion of stocks of large US firms. The proportion of its assets is in the same
proportion as in the S&P 500 index.
Vanguard European Stock Index (VEURX):
The Vanguard European Stock Index tracks the performance of the MSCI Europe
index. The fund is mainly composed of the assets in the MSCI Europe index, which
includes approximately 513 common stocks in Europe.
Vanguard Emerging Markets Stock Index (VEIEX):
The Vanguard Emerging Markets Stock Index tracks the performance of the MSCI
Emerging Markets index. The fund is mainly composed of the representative common
stocks in the MSCI Emerging Markets index, including about 781 common stocks of
firms in emerging markets.
Vanguard Long-Term Bond Index (VBLTX):
The Vanguard Long-Term Bond Index tracks the performance of a market-weighted
bond index, namely the Barclays Capital U.S. Long Government/Credit Float Adjusted
Index, which includes high-quality securities with a long-term average maturity of
approximately 15-30 years.
Vanguard Short-Term Bond Index (VBISX):
The Vanguard Short-Term Bond Index tracks the performance of a market-weighted
bond index, namely the Barclays Capital U.S. Long Government/Credit Float Adjusted
Index, which includes high-quality securities with a short-term average maturity of
approximately 1-5 years.
Vanguard Pacific Stock Index (VPACX):
The Vanguard Pacific Stock Index tracks the performance of the MSCI Pacific index.
The fund is mainly composed of common stocks of firms located in Japan, Australia,
Hong Kong, Singapore, and New Zealand.


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0.2 Summary of Results
The mutual funds that index groups of countries and large companies all had prices and
returns that dropped dramatically around mid-2011 to mid-2012, as a result of the Eurozone
Crisis and the downgrading of the countries credits.
The returns on VBLTX and VBISX appear to be normally distributed, while the returns on
the other four mutual funds do not appear to be normally distributed.
VFINX appears to have the highest expected return, and VEIEX is the most risky asset.
VBISX has the lowest expected return and risk of the six assets.
Sharpe ratio is a measure of the excess return per unit of risk in an investment. VBISX has
the highest Sharpe ratio, and VEIEX has the lowest.
A strong, precisely measured positive linear relationship can be observed between pairs of
equity funds. A lesser positive linear relationship can be observed between the two bond
funds. The relationship between pairs of stock and bond funds appears to be weak and
insignificant.
Holding a diversified portfolio of investments across different asset classes can reduce the
portfolio risk. However, holding only one class of assets is not as effective in reducing the
risk because of the high correlation between pairs of assets from the same class.
The Value-at-Risk (VaR) estimates for each asset using empirical quantiles are generally
higher than the VaR estimates assuming normal distribution. The 1%- and 5%-VaR
estimates of VEIEX for both time horizon assuming normal distribution appear to be the
highest, and that of VBISX appear to be the lowest. Using empirical quantiles, the monthly
1%-VaR estimate of VEIEX is the highest, and the monthly 5%-VaR estimate of VEURX is
the highest. The monthly 1%- and 5%-VaR estimates of VBISX are lowest.
The rolling analysis suggests that the six assets are not quite stationary, as their rolling
standard deviations display a slight downward trending behavior.
The global minimum portfolio with short-sales is mainly composed of investments in
VBISX, VFINX, and VPACX and shorting in VBLTX, VEURX, and VEIEX. The global
minimum portfolio without short-sales is mainly composed of investments in VBISX and
VFINX.

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The global minimum portfolio without short-sales has a higher expected return and standard
deviations than the global minimum portfolio with short-sales. Its potential loss (value-at-
risk) is also higher.
The tangency portfolio without short-sales has a slight higher return but also a higher
standard deviation than the tangency portfolio with short-sales. Its Sharpe ratio is also
relatively lower.
When risk free asset is introduced, the tangency portfolio return can be maintained with a
lower variance than the tangency portfolio without risk free asset.
























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1. Return Calculations and Sample Statistics
1.1 Time Trends of Mutual Fund Prices and Returns

Figure 1.1

Figure 1.2

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Figure 1.1 displays the time series of the prices of the six assets and Figure 1.2 displays the
time series of the respective returns. From Figure 1.1, a sharp decline in the prices can be
observed in the midst of 2011. In Figure 1.2, a fall in the returns can also be seen at the
same period. This behavior can be explained by the August 2011 stock markets fall, which
was due to fears of contagion of the Eurozone Crisis, and the downgrading in the USs and
other countries credits in 2011.


Figure 1.3
From Figure 1.3, VFINX gives the highest future value of $1. This is not a surprising result,
as VFINX is one of the assets that appears to be least affected by the Eurozone crisis in
Figure 1.1 and Figure 1.2.





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1.2 Normality of Monthly Continuously Compounded Returns






Figure 1.4



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From Figure 1.4, the returns on VBLTX and VBISX appear to be normally distributed. Their
Q-Q plots show that most of the data sets for these two assets lie roughly on the normal
distribution line. From the smoothed histograms and box plots, the two assets are also
observed to be symmetric and normal.
On the other hand, the returns on VFINX, VEURX, VEIEX, and VPACX do not appear to be
normal in the Q-Q plots. They display a very obvious deviation from the normal distribution
on the lower tail, and their smoothed histograms reveal clear left tails. From the box plots of
the four assets, the lower tails have several outliers, which further confirm the fact that they
are not normally distributed.

1.3 Univariate Descriptive Statistics
VFINX VEURX VEIEX VBLTX VBISX VPACX
Mean 0.013960 0.009936 0.006150 0.007912 0.002015 0.007338
Variance 0.001479 0.003298 0.003300 0.000639 0.000019 0.001828
S.D. 0.038455 0.057428 0.057444 0.025287 0.004351 0.042755
Skewness -0.425000 -0.456000 -0.374500 -0.054300 -0.444800 -0.689900
Kurtosis 0.234800 0.211100 0.927900 -0.306800 0.582000 0.481100
Figure 1.5
VFINX appears to have the highest average return with a mean of 1.40%. VEIEX appears to
be the most risky assets with a standard deviation of 5.74%. VBISX have the lowest average
return with a mean of 0.20%, and it also seems to be the least risky asset with a standard
deviation of 0.44%.

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VBLTX looks most normally distributed, as it has the lowest skewness of -0.05 and a
moderate excess kurtosis of -0.31. On the other hand, VPACX appears to be the least
normally distributed asset, as it has the highest skewness of -0.69 and a high excess kurtosis
of 0.48.

1.4 Sharpe Ratio
VFINX VEURX VEIEX VBLTX VBISX VPACX
Sharpe Ratio 0.3522 0.1658 0.0998 0.2964 0.3672 0.1619
Figure 1.6
Sharpe ratio is a measure of the excess return per unit of risk in an investment. From Figure
1.6, VBISX appears to have the highest Sharpe ratio, at a value of 0.3672.

1.5 Estimated Standard Error and 95% Confidence I nterval
VFINX VEURX VEIEX VBLTX VBISX VPACX
SE() 0.004965 0.007414 0.007416 0.003265 0.000562 0.005520
SE() 0.003510 0.005242 0.005244 0.002308 0.000397 0.003903
-Upper 0.023889 0.024763 0.020982 0.014441 0.003138 0.018377
-Lower 0.004031 -0.004892 -0.008682 0.001383 0.000891 -0.003701
-Upper 0.045476 0.067912 0.067932 0.029904 0.005145 0.050561
-Lower 0.031434 0.046943 0.046957 0.020670 0.003557 0.034949
Figure 1.7
The means do not appear to be estimated precisely, because the standard errors are
approximately the same as the estimates. The standard deviation are much more precisely
estimated, as their standard errors are relatively small. In comparison to the estimated means,
the estimated standard deviations are more precise.

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1.6 Monthly and Annual Estimates of the Returns
VFINX VEURX VEIEX VBLTX VBISX VPACX
Annual Est. Mean 0.167516 0.119229 0.073805 0.094944 0.024174 0.088059
Annual Est. SD 0.133213 0.198935 0.198993 0.087597 0.015072 0.148107
5-year Growth 2.310772 1.815107 1.446322 1.607565 1.128480 1.553163

Figure 1.8
Of the six assets, VFINX gives the highest estimated annual return of 16.75%. VEIEX
appears to be the most risky asset with the highest estimated annual standard deviation of
19.90%. On the other hand, VBISX has the lowest annual return of 2.42% but also the lowest
annual standard deviation of 1.51%.
From Figure 1.8, VFINX appears to have to highest 5-year growth of $1. Given $1 as the
initial investment, the investment can achieve a gross return of $2.17 after 5 years. In
comparison, VBISX achieves the lowest gross return of $1 investment, returning a gross
return of $1.13 after 5 years.













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1.7 Scatterplots, Covariance, and Correlation between the Returns

Figure 1.9 Pair-wise Scatterplots
From the pair-wise scatterplot in Figure 1.9, there appears to have strong positive correlation
between each pair of the equity funds. There is also a strong positive correlation between the
two bond funds. However, it appears that there is no correlation between the bond funds and
the equity funds.





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VFINX VEURX VEIEX VBLTX VBISX VPACX
VFINX 0.001479 0.001965 0.001801 -0.000383 0.000000 0.001320
VEURX 0.001965 0.003298 0.002834 -0.000429 0.000030 0.002057
VEIEX 0.001801 0.002834 0.003300 -0.000335 0.000037 0.001985
VBLTX -0.000383 -0.000429 -0.000335 0.000639 0.000065 -0.000266
VBISX 0.000000 0.000030 0.000037 0.000065 0.000019 0.000016
VPACX 0.001320 0.002057 0.001985 -0.000266 0.000016 0.001828
Figure 1.10 Covariance Matrix

VFINX VEURX VEIEX VBLTX VBISX VPACX
VFINX 1.000000 0.889965 0.815254 -0.392381 -0.002750 0.803798
VEURX 0.889965 1.000000 0.858453 -0.290296 0.121419 0.840824
VEIEX 0.815254 0.858453 1.000000 -0.225626 0.149990 0.810503
VBLTX -0.392381 -0.290296 -0.225626 1.000000 0.590404 -0.248217
VBISX -0.002750 0.121419 0.149990 0.590404 1.000000 0.086036
VPACX 0.803798 0.840824 0.810503 -0.248217 0.086036 1.000000
Figure 1.11 Correlation Matrix

VFINX VEURX VEIEX VBLTX VBISX VPACX
VFINX 0.0000 0.0269 0.0433 0.1089 0.1291 0.0459
VEURX 0.0269 0.0000 0.0338 0.1177 0.1269 0.0385
VEIEX 0.0433 0.0338 0.0000 0.1223 0.1257 0.0448
VBLTX 0.1089 0.1177 0.1223 0.0000 0.0852 0.1212
VBISX 0.1291 0.1269 0.1257 0.0852 0.0000 0.1279
VPACX 0.0459 0.0385 0.0448 0.1212 0.1279 0.0000
Figure 1.12 Correlation SE Matrix










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Upper Lower
VFINX-VEURX 0.9436 0.8361
VFINX-VEIEX 0.9020 0.7290
VFINX-VBLTX -0.1783 -0.6137
VFINX-VBISX 0.2633 -0.2531
VFINX-VPACX 0.8945 0.7108
VEURX-VEIEX 0.9267 0.7915
VEURX-VBLTX -0.0612 -0.5322
VEURX-VBISX 0.3852 -0.1222
VEURX-VPACX 0.9148 0.7609
VEIEX-VBLTX 0.0146 -0.4745
VEIEX-VBISX 0.4145 -0.0882
VEIEX-VPACX 0.8976 0.7184
VBLTX-VBISX 0.7537 0.4130
VBLTX-VPACX -0.0044 -0.4893
VBISX-VPACX 0.3517 -0.1600
Figure 1.13 Correlation 95% Confidence Interval
In Figure 1.10, all pairs of the equity funds and the pair of bond funds appear to be positively
related. The relation between the equity and the bond funds seem to be slightly negative.
From Figure 1.11, VFINX and VEURX appear to be the most correlated assets while VFINX
and VBISX appear to be the least correlated asset pair. Based on the estimated correlation
measures in Figure 1.11, holding a diversified portfolio composed of investments across
different asset classes would probably reduce the risk due to their negative correlation. On
the other hand, holding a portfolio of investments from the same asset class would be less
effective in reducing the risk because the correlation between investments of the same asset
class appear to be positive.

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2. Value-at-Risk (VaR) Calculations
2.1 Value-at-Risk Analysis
VFINX VEURX VEIEX VBLTX VBISX VPACX
A. Mean 0.1675 0.1192 0.0738 0.0949 0.0242 0.0881
A. SD 0.1332 0.1989 0.1990 0.0876 0.0151 0.1481
Figure 2.1

VaR VFINX VEURX VEIEX VBLTX VBISX VPACX
Monthly 1% -7272.10 -11632.10 -11969.40 -4964.00 -807.50 -8800.80
Monthly 5% -4809.80 -8105.10 -8454.80 -3312.10 -512.90 -6104.50
Annual 1% -13271.00 -29076.00 -32235.00 -10312.00 -1083.00 -22624.00
Annual 5% -5029.09 -18778.50 -22392.83 -4795.29 -61.71 -14406.09
Figure 2.2
In Figure 2.2, for both one-month and annual time horizon, VEIEX has the highest VaR and
VBISX has the lowest VaR for both 5% and 1% estimates.

2.2 Value-at-Risk Analysis with Bootstrap
5% VaR Std. Error Upper Lower
VFINX -4810.0 800.6 -6415.0 -3277.0
VEURX -8105.0 1250.0 -10707.0 -5808.0
VEIEX -8455.0 1208.0 -10968.0 -6235.0
VBLTX -3312.0 473.0 -4270.0 -2416.0
VBISX -512.9 103.3 -719.8 -315.0
VPACX -6104.0 944.7 -8060.0 -4357.0
Figure 2.3
For each of the assets, the standard errors appear to be fairly small relative to their VaR
estimates. The SE for each assets are roughly one-sixth of the VaR estimates. According to
the results from bootstraping, the true VaR of VFINX is in between -$6415 and -3277 at 95%
confidence level. Similarly for other assets, the 5% VaR estimates appear to be precise.

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2.3 Value-at-Risk Analysis with Empirical Quantiles
VFINX VEURX VEIEX VBLTX VBISX VPACX
M. 1% Q. -0.0774 -0.1287 -0.1415 -0.0500 -0.0088 -0.1017
M. 5% Q. -0.0563 -0.1067 -0.0901 -0.0298 -0.0048 -0.0798
A. 1% Q. -0.1489 -0.3609 -0.4378 -0.1055 -0.0134 -0.2898
A. 5% Q. -0.0760 -0.2847 -0.2598 -0.0355 0.0004 -0.2136
M. 1% VaR -7445.79 -12072.95 -13198.50 -4872.39 -879.14 -9672.84
M. 5% VaR -5476.57 -10118.72 -8620.10 -2931.83 -482.47 -7665.61
A. 1% VaR -13832.75 -30294.43 -35456.45 -10012.55 -1330.08 -25156.43
A. 5% VaR -7313.75 -24779.02 -22877.11 -3491.59 44.21 -19236.09
Figure 2.4
In Figure 2.4, the monthly and annual VaR calculated from the empirical quantiles are
generally higher by about $1000 to $3000 in comparison to the VaR, which can be a big
difference for each assets. Interestingly, the VaR calculated from the empirical quantiles for
VBLTX and VBISX are lower. In fact, the annual VaR calculated from the annualized
empirical quantile for VBISX is positive, indicating that investing in VBISX will guarantee
return at the 5% significance level.













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3. Rolling Analysis
3.1 Rolling Mean and Standard Deviation

Figure 3.1
For VFINX, the rolling mean seems to be constant over time, at around 0.01. The rolling
standard deviation displays an obvious, slight fall over the period.


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Figure 3.2
For VEURX, the rolling mean remains close to 0 for most of the time, but it displays an
increase toward the end of 2013. Its rolling standard deviation shows a downward trend.


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Figure 3.3
For VEIEX, the rolling means is constant and close to 0 throughout the time. Its rolling
standard deviation, however, appears to be decreasing slowly.


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Figure 3.4
For VBLTX, the rolling means appears to be constant, but it has a slight decrease to 0 in the
year of 2013 and remains constant after that. Its rolling standard deviation appears to be
constant throughout the time period.


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Figure 3.5
For VBISX, both of its rolling means and rolling standard deviations are constant throughout
the time. However, they do display a slight, downward trend.


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Figure 3.6
For VPACX, its rolling means is constant and close to 0 throughout the time period, although
it seems to increase to about 0.01 toward the end of 2013. Its rolling standard deviation is
constant with a slight downward trend.












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4. Portfolio Theory
4.1.Global Minimum Variance Portfolio with Short-Sales
Monthly Annual Portfolio Sharpe
Ratio Return SD Return SD
0.001719 0.003588 0.020628 0.012429 0.3629
Portfolio Weight
VFINX VEURX VEIEX VBLTX VBISX VPACX
0.0479 -0.0392 -0.0196 -0.0905 1.0873 0.014
Figure 4.1

Figure 4.2
In the global minimum variance portfolio, VEURX, VEIEX, and VBLTX all have negative
weights, meaning that these three assets are shorted in the portfolio. The portfolios expected
return is relatively lower in comparison to each asset. However, the volatility of the portfolio
is much lower than those of the individual asset.


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4.2.Value-at-Risk for Global Minimum Variance Portfolio with Short-Sales
Quantile VaR
1% -0.00663 -660.478
5% -0.00418 -417.452
Figure 4.3
In Figure 4.3, the VaR values for the global minimum variance portfolio with short sales is
lower than the VaR values for the individual assets, indicating that the portfolio is successful
in reducing the volatility, or risk, in the investment.

4.3.Global Minimum Variance Portfolio without Short-Sales
Monthly Annual Portfolio Sharpe
Ratio Return SD Return SD
0.002142 0.004314 0.025704 0.014944 0.4
Portfolio Weight
VFINX VEURX VEIEX VBLTX VBISX VPACX
0.012 0.000 0.000 0.000 0.988 0.000
Figure 4.4

Figure 4.5

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In comparison to the efficient portfolio with short sales in Section 4.1, the efficient portfolio
without short sales yields a higher expected monthly return of about 0.21%. However, its
monthly standard deviation is also higher, at about 0.43%.

4.4.Value-at-Risk for Global Minimum Variance Portfolio without Short-Sales
Quantile VaR
1% -0.00789 -786.13
5% -0.00495 -494.228
Figure 4.6
In Figure 4.6, the VaR for the global minimum variance portfolio with the restriction of no
short-sales is slightly higher than that for the global minimum variance portfolio that allows
short-sales. This indicates that the portfolio that allows short-sales is more successful in
reducing the risk of investment than when without short-sales.









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4.5.Efficient Portfolio Frontier using Markowitz Algorithm

Figure 4.7
In Figure 4.7, the portfolio frontier is plotted as the blue dotted line. The global minimum
variance portfolio is indicated as the red point. The efficient portfolio with the same return as
VFINX is indicated as the orange point.







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4.6.Tangency Portfolio with Short-Sales
Monthly Annual Portfolio Sharpe
Ratio Return SD Return SD
0.006456 0.007728 0.077472 0.026771 0.7815
Portfolio Weight
VFINX VEURX VEIEX VBLTX VBISX VPACX
0.3988 -0.1066 -0.0935 0.1655 0.6469 -0.0111
Variance
0.000060
Figure 4.8

Figure 4.9
The weight on VEURX, VEIEX, VPACX are negative, meaning that in the tangency
portfolio with short sales, these three assets are shorted.
The expected return of the tangency portfolio is about 3 times higher than that of the efficient
portfolio, yet its volatility is less than 2 times of that of the efficient portfolio.

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Figure 4.10
In Figure 4.10, the portfolio frontier is plotted as the blue dotted line. The green line indicate
the combination of the tangency portfolio and T-bills. The yellow point indicates the global
minimum variance portfolio, and red point indicates the tangency portfolio with short sales.








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4.7.Tangency Portfolio without Short-Sales
Monthly Annual Portfolio Sharpe
Ratio Return SD Return SD
0.006897 0.01087 0.082764 0.037655 0.5959
Portfolio Weight
VFINX VEURX VEIEX VBLTX VBISX VPACX
0.2506 0.0000 0.0000 0.3209 0.4285 0.0000
Variance
0.000118
Figure 4.11

Figure 4.12
In the tangency portfolio without short sales, the portfolio is mainly consisted of investments
in VFINX, VBLTX, and VBISX. In comparison to the tangency where short sales are
allowed, this tangency portfolio yields a slightly higher expected monthly return of about
0.69% and a higher volatility of 1.09%.

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5. Asset Allocation
5.1.Portfolio with Only Risky I nvestment
Return SD
0.005 0.00775
Portfolio Weight
VFINX VEURX VEIEX VBLTX VBISX VPACX
0.1614 0.0000 0.0000 0.1808 0.6508 0.0000
Figure 5.1
The efficient portfolio with only risky investments and a targeted expected return of 6% per
year, or 0.5% per month, is mainly consisted of investments in VFINX, VBLTX, and
VBISX, with 16.14% in VFINX, 18.08% in VBLTX, and 65.08% in VBISX. The standard
deviation of this portfolio is about 0.78%

5.2.Value-at-Risk for Portfolio with Only Risk I nvestment
Quantile VaR
1% -0.0131 -1301.09
5% -0.0078 -776.777
Figure 5.2
From Figure 5.2, the monthly 1% VaR of the portfolio with only risky investments is a loss
of $1301.09, and the monthly 5% VaR is a loss of $776.78.

5.3.Portfolio with Tangency Portfolio and T-Bills
Return SD Tangency T-Bills
0.005 0.007691 0.7073 0.2927
Portfolio Weight
VFINX VEURX VEIEX VBLTX VBISX VPACX
0.1773 0.0000 0.0000 0.2269 0.3031 0.0000
Figure 5.3

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The efficient portfolio that uses a combination of the tangency portfolio and T-bills and has a
targeted expected return of 6% per year, or 0.5% per month, is composed of 70.73% of the
tangency portfolio and 29.27% of T-bills. 17.73% is invested in VFINX, 22.69% in VBLTX,
and 30.31% in VBISX. The standard deviation of this portfolio is 0.77%, which is just
slightly lower than the efficient portfolio with only risky investments.

5.4.Value-at-Risk for Portfolio with Tangency Portfolio and T-Bills
Quantile VaR
1% -0.01289 -1280.66
5% -0.00765 -762.25
Figure 5.4
From Figure 5.4, the monthly 1% VaR of the portfolio with a combination of the tangency
portfolio and T-bills is a loss of $1280.66, and the monthly 5% VaR is a loss of $762.25. In
comparison to the efficient portfolio with only risky investments, these VaR values are
slightly lower, indicating that this portfolio is more successful in reducing the risk of
investment.