Question

Use the following table to answer the question below.

	Expected ret.	std. dev.
S&P500	13%	25%
ABC Fund	20%	29%
T-bill	4%
Borrow	8%

What is the highest fee that a client who is currently borrowing would be willing to pay to invest in ABC fund instead of S&P500?

Round your answer to 4 decimal places. For example, if your answer is 3.205%, then please write down 0.0321.

Answer 1

Market price of risk for S$P 500 = (Expected return of S&P- Expected return of borrow ) / standard deviation of S&P

= (0.13 - 0.08) / 0.25
= 0.05 / 0.25
= 0.2

Market price of risk for ABC = (Expected return of ABC - Expected return of borrow ) / standard deviation of ABC

= (0.20 - 0.08) / 0.29
= 0.12 / 0.29
= 0.41379

The highest fee that a client who is currently borrowing would be willing to pay to invest in ABC fund instead of S&P500=

0.41379 - 0.2 = 0.21379

i.e 0.2138 or 21.38%