The risk-free rate, average returns, standard deviations, and betas for three fu
ID: 2799540 • Letter: T
Question
The risk-free rate, average returns, standard deviations, and betas for three funds and the S&P 500 are given below.
If these portfolios are subcomponents that make up part of a well-diversified portfolio, then portfolio __________ is preferred.
Multiple Choice
A
S&P 500
B
C
The risk-free rate, average returns, standard deviations, and betas for three funds and the S&P 500 are given below.
If these portfolios are subcomponents that make up part of a well-diversified portfolio, then portfolio __________ is preferred.
Multiple Choice
A
S&P 500
B
C
Fund Avg Std Dev 11.0% 28.0% Beta 1.20 13.0% 24.5% 1.25 16.5% 31.5% 1.45 S&P; 500 10% 18% 3.0%Explanation / Answer
We calculate the expected return of each portfolio by the CAPM formulae as it takes into account the systematic risk
Return = Risk free rate + Beta * (Market return - Risk free rate)
Portfolio A = 3% + 1.2*(10%-3%) = 11.4%
Portfolio B = 3% + 1.25*(10%-3%) = 11.75%
Portfolio C = 3% + 1.45*(10%-3%) = 13.15%
S&P 500 = 3% + 1*(10%-3%) = 10%
Based on above returns Portfolio of fund C is the most preferred.
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