Question

Fidelity large cap fund has a Sharp ratio of 0.7 and expected return of 18%. Fidelity small cap has a Sharpe ratio of 0.5 and expected return of 20%. Which fund should a risk-averse investor prefer if he/she likes to construct a portfolio using the risk-free and one of the funds?

A) Fidelity small cap B) Fidelity large cap C) Allocate 50% to each funds D) Only risk free asset E) None of the above 4 points

QUESTION 8 You own TSLA stock however you are concerned about volatility. So you decide to add another stock which has a correlation coefficient of 1 with TESLA. By doing so what kind of risk did you reduce? A. Market risk B. Company specific risk C. Unsystematic risk D. Inflation risk E. None of the above

Answer 1

The investor is a risk-averse investor which means he/she does not like to take risk. In this case the investor will construct a portfolio with risk free asset and Fidelity large cap fund

A) Fidelity large cap fund as the sharpe ratio of this fund is higher than small cap fund and higher sharpe ratio is considerd good as compared to lower sharpe ratio.

SOLUTION Question 8: If a stock is added with TESLA which has correlation coefficient of 1 with TESLA then only Company specific risk (B) will be reduced. In other words, if both the stocks have perfect correlation their returns will move in same direction so market risk, unsystematic risk and inflation risk will not be reduced. Only risk which will be specific to these companies will be reduced.