You are a portfolio manager for the XYZ investment fund. The objective for the fund is to maximize your portfolio returns from the investments on four alternatives. The investments include (1) stocks, (2) real estate, (3) bonds, and (4) certificate of deposit (CD). Your total investment portfolio is $1,000,000.
Based on the returns from the past five years, you concluded that the investment annual returns on stocks are 10%, on real estates are 7% on bonds are 4% and on CD is 1%.
However, you also have to analyze the risks associate with each investment category. A wildly used risk measurement parameter is called Value at Risk (VaR). (Note: VaR measures the risk of loss on a specific portfolio of financial assets.) For example, given a million dollar stock investment, if a portfolio of stocks has a one-day 4% VaR, there is a 5% probability that the stock portfolio will fall in value by more than 1,000,000 * 0.004 = $4,000 over a one day period. In the portfolio, the VaR for stock investments is 6%. Similarly, the VaR for real estate investment is 2% and the VaR for bond investment is 1% and the VaR for investment in CD is 0%. To manage the portfolio, you decided that at 5% probability, your VaR for stocks cannot exceed $25,000, VaR for real estate cannot exceed $15,000, VaR for bonds cannot exceed $2,500 and the VaR for CD investment is $0.
Diversification and Liquidity Constraints
As a diversified investment portfolio, you also decided that each investment category must hold at least $50,000 of the total investment assets. In addition, you must hold combined CD and bond investment no less than $200,000 in order to meet liquidity requirement.
The total amount of real estate holding shall not exceed 30% of the portfolio assets.
1. Please identify the objective function. Z=?
2. Identify all constraints in a formula.