You are considering the risk-return profile of two mutual funds for investment.

Question

You are considering the risk-return profile of two mutual funds for investment. The relatively risky fund promises an expected return of 8% with a standard deviation of 14%. The relatively less risky fund promises an expected return and standard deviation of 4% and 5%, respectively. Assume that the returns are approximately normally distributed. Use Table 1 a-1. Calculate the probability of earning a negative return for each fund. (Round "z" value to 2 decimal places and final answer to 4 decimal places.) Probability Riskier fund Less risky fund a-2. Which mutual fund will you pick if your objective is to minimize the probability of earning a negative return? Riskier fund Less risky fund b-1. Calculate the probability of earning a return above 8% for each fund. (Round "z" value to 2 decimal places and final answer to 4 decimal places.) Probability Riskier fund Less risky fund b-2. Which mutual fund will you pick if your objective is to maximize the probability of earning a return above 8%? Riskier fund O Less risky fund

Explanation / Answer

Answer to the question is as follows:

a-1

P(Riskier fund return <0)
= P(Z<(0-8 / 14))
= P(Z< -8/14)
= .2839

P(Les risky fund return <0)
= P(Z< 0-4/5)
= P(Z<-.8)
= .2119

a-2)
I will pick the less risky fund if i've to minimize probability of earning
-ive return

a-3)

P(>8% in riskier fund) = P(Z>(8%-8%)/14%) = .50
P(>8% in less risky fund) = P(Z> 8%-4%/5%) = P(Z> .80) = .2119

b-2)
So, probabiltiy of earning more than 8% is more for riskier fund,
and to maximize the probability this is fund you have to choose

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