On page 178-179, three portfolios (A, D1, D2) are discussed in the context of present value of expected contributions and contribution risk. The text notes that Portfolio D2 ought to be given “serious consideration” because this portfolio leads to significantly lower contribution risk and only slightly higher expected PV of contributions than Portfolio A. Portfolio D2 achieves this optimal mix by reducing equity from 70% to 60% and by lengthening its bonds. The equity reduction results in a lower discount rate, and thus, a slightly higher PV of contributions. Yet, if you look at where Portfolio D2 plots on the Y axis of Exhibit 2 (page 179), the PV of expected contributions is actually lower, moving from about $50MM for Portfolio A to $48MM for D2. This directly contradicts what is stated in the second sentence of the text below Exhibit 2, where the text notes that the expected PV of contribution is higher . What am I missing?
In my textbook, D2 has a slightly higher PV of contribution than A in Exhibit 2.
Really? I assume you’re using the 2020 curriculum book. Are you sure you’re not looking at the Y axis incorrectly? Because in order for D2 to have a higher PV of expected contribution than A, it actually has to be further south on the Y axis in this case since the lower PV of contribution labels are in ascending order (e.g. 40 is the top of the Y axis and 120 is the bottom of the Y axis).
what do you say to that???
You’re right. I missed out on the Y axis being ordered from lowest at the top to highest at the bottom.
D2 should be further south to shower a higher PV of expected contribution than A.
I don’t see anything highlighted in the Level 3 errata so you may want to highlight that to CFAI.