I’m having trouble understanding the last sentence here:
“Hedging/return-seeking portfolios approach . This approach involves separating assets into two groups: a hedging portfolio and a return-seeking portfolio. The reading also refers to this as the two-portfolio approach. The concept of allocating assets to two distinct portfolios can be applied for various funding ratios, but the reading distinguishes as the basic approach the case in which there is a positive surplus available to allocate to the return-seeking portfolio.”
Is having a surplus a prerequisite for applying the two portfolio approach? I have seen mixed answers from various mock exams…
For my understanding, the surplus will be used for return-seeking and the rest is for hedging. Hence, having a surplus is a prerequisite.
that’s my understanding as well. However in one MM mock exam solution it stated that “both surplus optimization and H-RS can handle any funded status…”.
After re-reading the chapter in the curriculum, the book says for H-RS requires “Positive funded ratio for basic approach”, and if the fund is underfunded it can only use a variant of H-RS such as the partial hedge.
So I guess MM is not incorrect, but the statement can be a bit misleading to simply state H-RS can handle any funded ratio.
For Basic approach, Funded Ratio has to be greater than 1.
you are right - probably worth submitting an erratum to CFA