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Why is not C? She states that she has a significant portion of her portfolio in short-term bonds and money market funds to offset the risk of her AutoPay shares. She does consider the covariance between assets since short-term bonds and money market funds have low correlation with stock, which can reduce the risk of her portfolio.
C says he isnt correct. It doesnt say he’s correct about covariance.
Should it not say “…subject to mental accounting,is NOT constructed oin layers”?
What was the answer, not A?
Why does she have mental accounting? It does not mention she has separate goals. And she does consider the covariance of assets because she allocate short-term bonds and money market funds, which have low correlation with stock, to reduce the risk of portfolio.
The answer “C” is saying she does not consider covariance, which is why it isn’t C. YOu are correct, she does consider covariance. Read the answer again.
Solution
B is correct. Owen’s comment regarding Steven’s current portfolio construction is not correct. Her current portfolio is subject to mental accounting, has been constructed in layers and does not take into consideration covariance between assets.
A is incorrect because Owen’s comment regarding Steven’s current portfolio construction is not correct, therefore “yes” is incorrect.
C is incorrect because Owen’s comment regarding Steven’s current portfolio construction not taking into consideration covariance between assets is correct.
Yes, exactly. B is correct because “not constructed in layers,” is wrong.
Why? She does not construct in layers because she does not have separate goals. She allocates short-term bonds and money market funds because she wants to reduce overall risk of portfolio, not to address different goals.
Layers doesnt have to mean separate goals. Layers means you don’t understand that money is fungible. She has her risky money layer and her safe money layer.
Google Mental Accounting: Mental accounting refers to the tendency people have to separate their money into different accounts based on miscellaneous subjective criteria, including the source of the money and the intended use for each account.
But how do you understand this: “She states that she has a significant portion of her portfolio in short-term bonds and money market funds to offset the risk of her AutoPay shares.”
She allocate short-term bonds and money market funds, which have low correlation with stock, to reduce portfolio risk. Therefore, she does consider the covariance with assets. If she constructs portfolio into layers, she should construct the layer for short-term bonds and money market funds without considering the characteristics of other layers. But she does consider the risk of another layer (AutoPay shares).
You don’t know that she’s considered the covariance (of returns). When she says that they offset the risk, she may simply mean that she thinks that adding investments with lower standard deviations of returns will lower the overall standard deviation of returns. And she’s correct, even if the correlation of returns is +1.0.
The suspense was building all day and now it’s very anti-climatic.
I do see where the original question came from, that from the question it does indicates or at least implies that the investor has considered covariance - by diversifying her portfolio via bond/low risk asset exposures. It also indicates that she does construct her portfolio using layers as she obviously uses her stock portion to capture the gain from the IPO, and the bond portion as a hedging layer.