E 24 You are considering two mutual funds for your investment. The possible retu

Question

E 24

You are considering two mutual funds for your investment. The possible returns for the funds are dependent on the state of the economy and are given in the accompanying table.

You believe that the likelihood is 20% that the economy will be good, 50% that it will be fair, and 30% that it will be poor.

Find the expected value and the standard deviation of returns for Fund 1. (Round your intermediate calculations to 4 decimal places and final answers to 2 decimal places.)

Find the expected value and the standard deviation of returns for Fund 2. (Round your intermediate calculations to 4 decimal places and final answers to 2 decimal places.)

Which fund will you pick if you are risk averse?

You are considering two mutual funds for your investment. The possible returns for the funds are dependent on the state of the economy and are given in the accompanying table.

Explanation / Answer

Solution:

a) The Expected Value for Fund 1 is = 0.2(0.2) + 0.5(0.1) - 0.3(0.1)

= 0.06 or 6%

The standard deviation of Fund 1 return is = sqrt(0.2*(0.2-0.06)2 + 0.5*(0.1-0.06)2 + 0.3*(-0.1-0.06)2)

= 0.1114

b) The Expected Value for Fund 2 is =  0.2(0.4) + 0.5(0.2) - 0.3(0.4)

= 0.06 or 6%

The standard deviation of Fund 2 return is = sqrt(0.2*(0.4-0.06)2+0.5*(0.2-0.06)2+0.3*(-0.4-0.06)2)

= 0.3105

c) Risk aversion is less in case of Fund 1

hence, Fund 1 because it has lower risk.

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