You are going to invest in a stock mutual fund with a 7 percent front-end load a

Question

You are going to invest in a stock mutual fund with a 7 percent front-end load and a 1.35 percent expense ratio. You also can invest in a money market mutual fund with a 2.8 percent return and an expense ratio of .30 percent. If you plan to keep your investment for 2 years, what annual return must the stock mutual fund earn to exceed an investment in the money market fund? What if your investment horizon is 9 years? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)

Explanation / Answer

The toal return of the money market fund = 2.8 = 0.3 = 2.5% per annum

For 2 years, the return of the money market fund = (1+0.025)^2 -1 = 0.05 = 5.0625%

Suppose we invest 10,000USD in this money market fund, the return after 2 years = 10506.25

In order to earn a similar return, the rate should be as follows:

So the amount avialable for investment = 10,000*(1-0.07) = 9,300 since there is 7% inital investment

So 9,300*(1+r)^2 = 10,506.25

r = 0.06287

With an expense of 1.35%(0.0136) =  0.06287 + 0.0135 = 0.07638 = 7.64%

The annual return of the nutual fund should be at least 7.64% or greater to exceed the money market fund if the money is invested for 2 years.

Now, if the investment is for 9 years, the money market fund will yield = 10000*1.025^ 9 = 12,488.63

So the equation becomes

9300*(1+r)^9 = 12,488.63

r = 0.033298

With expense ratio , rate should be 0.033298 + 0.0135 = 0.046798 = 4.68%

The annual return of the nutual fund should be at least 4.68% or greater to exceed the money market fund if the money is invested for 9 years.

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.