The table below presents performance data for two mutual funds over the last 5 y

Question

The table below presents performance data for two mutual funds over the last 5 years -- the Socially Responsible Fund, and the Diamonds Are Forever Resource Fund. The table also includes information on the returns of the market index and T-Bills over the same period. Use this information to answer the question that follows.

Return

Standard Deviation

Beta

Responsible

14.4%

37%

2.7

Diamonds

8%

30.40%

2.2

Market

4.0%

12%

1

T-Bills

1%

N/A

N/A

If you had invested in the market portfolio and T-Bills in such a way as to match the beta of Diamonds Are Forever, then what return would you have earned?

The return on your portfolio would have been

nothing%

Return

Standard Deviation

Beta

Responsible

14.4%

37%

2.7

Diamonds

8%

30.40%

2.2

Market

4.0%

12%

1

T-Bills

1%

N/A

N/A

Explanation / Answer

Using CAPM,

Expected Returns E(R) = Rf + beta x (Rm - Rf)

here, Rf - Risk-free rate = 1%, beta = 2.2 for Diamonds, Rm - Market Returns = 4%

=> E(R) = 1% + 2.2 x (4% - 1%) = 7.60%

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