You estimate that a passive portfolio, that is, one invested in a risky portfolio that mimics the S&P 500 stock index, yields an expected rate of return of 13% with a standard deviation of 25%. You manage an active portfolio with expected return 18% and standard deviation 28%. The risk-free rate is 8%. i) Draw the CML and your funds' CAL on an expected return-standard deviation diagram. ii) What is the slope of the CML? iii) Characterize in one short paragraph the advantage of your fund over the passive fund. iv) Your client ponders whether to switch the 70% that is invested in your fund to the passive portfolio. Explain to your client the disadvantage of the switch. Also, show him the maximum fee you could charge (as a percentage of the investment in your fund, deducted at the end of the year) that would leave him at least as well off investing in your fund as in the passive one. ( Hint: The fee will lower the slope of his CAL by reducing the expected return net of the fee.) v) If he chose to invest in the passive portfolio, what proportion, y, would he select? Assume that the investor has a risk aversion of 3.5. vi) Is the fee (percentage of the investment in your fund, deducted at the end of the year) that you can charge to make the client indifferent between your fund and the passive strategy affected by his capital allocation decision (i.e., his choice of y )?
You estimate that a passive portfolio, that is, one invested in a risky portfolio that mimics the S&P 500 stock index, yields an expected rate of return of 13% with a standard deviation of 25%. You manage an active portfolio with expected return 18% and standard deviation 28%. The risk-free rate is 8%. i) Draw the CML and your funds' CAL on an expected return-standard deviation diagram. ii) What is the slope of the CML? iii) Characterize in one short paragraph the advantage of your fund over the passive fund. iv) Your client ponders whether to switch the 70% that is invested in your fund to the passive portfolio. Explain to your client the disadvantage of the switch. Also, show him the maximum fee you could charge (as a percentage of the investment in your fund, deducted at the end of the year) that would leave him at least as well off investing in your fund as in the passive one. ( Hint: The fee will lower the slope of his CAL by reducing the expected return net of the fee.) v) If he chose to invest in the passive portfolio, what proportion, y, would he select? Assume that the investor has a risk aversion of 3.5. vi) Is the fee (percentage of the investment in your fund, deducted at the end of the year) that you can charge to make the client indifferent between your fund and the passive strategy affected by his capital allocation decision (i.e., his choice of y )?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
answer iv, v, vi
Transcribed Image Text:You estimate that a passive portfolio, that is, one invested in a risky portfolio that mimics the S&P
500 stock index, yields an expected rate of return of 13% with a standard deviation of 25%. You
manage an active portfolio with expected return 18% and standard deviation 28%. The risk-free rate
is 8%.
i) Draw the CML and your funds' CAL on an expected return-standard deviation diagram.
ii) What is the slope of the CML?
iii) Characterize in one short paragraph the advantage of your fund over the passive fund.
iv) Your client ponders whether to switch the 70% that is invested in your fund to the passive
portfolio. Explain to your client the disadvantage of the switch. Also, show him the maximum fee
you could charge (as a percentage of the investment in your fund, deducted at the end of the year)
that would leave him at least as well off investing in your fund as in the passive one. ( Hint: The fee
will lower the slope of his CAL by reducing the expected return net of the fee.)
v) If he chose to invest in the passive portfolio, what proportion, y, would he select? Assume that the
investor has a risk aversion of 3.5.
vi) Is the fee (percentage of the investment in your fund, deducted at the end of the year) that you
can charge to make the client indifferent between your fund and the passive strategy affected by his
capital allocation decision (i.e., his choice of y )?
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 5 steps
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education