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.

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.)

Which mutual fund will you pick if your objective is to minimize the probability of earning a negative return?

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.)

Which mutual fund will you pick if your objective is to maximize the probability of earning a return above 8%?

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.

Explanation / Answer

Solution:

Risky
Pr[Z<0-0.08/0.14] = Pr[Z < -0.57]
= 0.2843
Less Risky
= Pr{Z < 0-0.04/0.05]
= Pr[Z < -0.8]
=0.2119

a-2) Less risky fund
b-1) Pr[Z > 0.08-0.08/0.14]
=Pr[Z > -0.49] = 0.3121
riskier fund
Pr[Z > 0.08-0.08/0.05]
=Pr[Z > -1.52] = 0.0642
b-2) riskier fund

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