1. Consider the table below showing return and risk for two funds. Mutual Funds
ID: 1175468 • Letter: 1
Question
1. Consider the table below showing return and risk for two funds.
Mutual Funds
Returns
Standard Deviation
Fund A : Well diversified value fund
9%
17%
Fund B: A risk less Fund
3.5%
0%
A. Calculate and show risk and return for a security consisting of 60 % in risky fund and 40 % risk less fund, in the context of the CAPM. Show calculations. (25 points)
B. Calculate and show return and risk for a portfolio consisting of 125 % in risky fund in the context of CAPM. Show calculations. (20 Points)
Mutual Funds
Returns
Standard Deviation
Fund A : Well diversified value fund
9%
17%
Fund B: A risk less Fund
3.5%
0%
Explanation / Answer
Solution
A) Risk and Return
1) Risk of security = Weight of Fund A * Standard deviation of A + Weight of B * Standard deviation of B
Risk of security = (17%*0.6) + (0%*0.4)
Risk of security = 10.2%
2) Return of security
Return of security = (9%*0.6) + (3.5%*0.4) = 6.8%
B) Risk and return
1) Risk of security = (17%*1.25) + (0%)*(-0.25) = 21.25%
2) Return on security = (9%*1.25) + (3.5%)*(-0.25) = 10.375%
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