Question

Four of your best friends from college are now mutual fund managers (maybe you should have kept in touch after graduation).  The risk-free rate was 2 percent and the S&P 500 market risk premium was 10 percent for 2019.  Using the Capital Asset Pricing Model, provide the benchmark Security Market Line predicted return for each fund in 2019 and place them in the table below.

Fund Manager	2019 Performance	BETA	StdDev	Corr.	SML Predicted Return
Devo	8%	0.55	11%	25%
Grodge	11	0.70	7	50
MsMo	13	1.20	12	50
SpaceMan	18	1.60	10	80

a.         Which of your friends has the fund with the highest market risk?  The highest total risk?

            Highest Market Risk             _______

            

Highest Total Risk    _______

b.         Compared to the SML benchmark, which of your friends had the best performance?   The worst?

            Best Performance     ______

            Worst Performance  ______

c.         You have estimated that MsMo will provide a return of 12% for investors in 2020, while the risk-free rate is 3 percent and the S&P 500 market risk premium is 8.0 percent for 2020. Given these estimates, do you feel that MsMo will out-perform or under-perform the market benchmark?  (Circle 0ne)

            Out-Perform  Under-Perform

            Market Benchmark _________

d.         What is the implied standard deviation of the returns for the Standard & Poor 500 (market return) used to compute the betas in the table above?

e.         You have decided to invest 25% of your funds with each of your friends.  What will be the beta of your investment portfolio adopting this strategy?  

            Beta ______

Answer 1

SML Predicted Return
	Re = Rf+ (Rm-Rf)Bita
Fund Manager	SML Predicted Return	SML Predicted Return
Devo	2+10* .55	7.5
Grodge	2+10*.70	9
MsMo	2+10*1.20	14
SpaceMan	2+10*1.60	18
Market Risk
Fund Manager	Bita = co-relation cofficient of portfolio with market * standard deviation of asset/Market Standard Deviation	Market Risk	Market Risk
Devo	0.55 = .25*.11/Market Standard Deviation	Market Standard Deviation =.25*.11*.55	1.51
Grodge	0.70 = .50*.07/Market Standard Deviation	Market Standard Deviation =.70*.50*.07	1.51
MsMo	1.20 = .50*.12/Market Standard Deviation	Market Standard Deviation =1.2*.50*.12	7.20
SpaceMan	1.60 = .80*.10/Market Standard Deviation	Market Standard Deviation =1.6*.80*.10	12.80

In view of the above, it is apparent that SpaceMan has the fund with higest market risk.

Fund Manager	SML Predicted Return	Actual Return in 2019	Difference	Comments
Devo	7.5	8	0.5	Actual return is more than expected rate of return
Grodge	9	11	2	Actual return is more than expected rate of return
MsMo	14	13	-1	Actual return is less than expected rate of return
SpaceMan	18	18	0	Actual return is equal to expected rate of return

In view of the above, as it is apparent that as actual retrun of Grodge is more than 2% of expected return, same is considered as best performing fund. On the ther hand, as actual retrun of MsMO is less than 1% of the expected return, same is considered as worst performing fund.

C) Expected return of MsMO would be as follows;

Re = Rf + (Rm-Rf)Bita

Re = 3+8(1.20) [ presuming that Bita of MsMo will remain same in 2020 as well)

Re = 3+9.6

Re = 12.60