IPS Quiz: Asset selection

Tony Mitchell, a college professor, is considering investing in a mutual fund. His number one priority is long-term capital appreciation. He will take above-average risk in exchange for the possibility of outperforming the market. Tony is 30 years old and expects to be at the university until age 70. Which fund is more appropriate for Mitchell? Mutual Fund A: Balanced Five year return 14% Standard deviation = 12 Consists of 40% growth stocks, 60% preferred stocks Mutual Fund B: Growth and Income Five year return 12% Standard Deviation = 7 Consists of 60% growth stocks and 40% high dividend stocks A) A, because it has a better risk/return relationship. B) B, because it has a better risk/return relationship. C) A, because of its higher five year return.

B. Better Sharpe assuming Rf is constant for both.

darlia Wrote: ------------------------------------------------------- > B. Better Sharpe assuming Rf is constant for both. why Sharpe? He looking for high return, and it seems he does not mind higher risk.

B? Better Sharpe ratio, which means better risk/return relationship. The five year return thing looks fishy given his long term time horizon, and the low risk HC means 60% growth stocks is fine. -to answer your question, return alone isn’t the only factor, especially when it specifies 5 years.

The additional amount of risk (+5%) he’d incur for a 2% bump in return seems excessive. Plus, his human capital (college professor) is fixed income-like, so he’d want to have more exposure to growth stocks and less exposure to income stocks. B!

all about risk per unit of return. the entire curriculum is about this.

B coz of sharpe. He will also be invested in a higher percentage of growth stocks in portfolio b.

B, high ability and willingness to take risk (stable bond-like human capital/stated desire for capital appreciation)…also the higher Sharpe ratio




B, b/c his human capital risk is LOW, thus he can take more risk in equity portfolio and should have a higher allocation to growth equities, which is portfolio B

hellscream Wrote: ------------------------------------------------------- > darlia Wrote: > -------------------------------------------------- > ----- > > B. Better Sharpe assuming Rf is constant for > both. > > > why Sharpe? He looking for high return, and it > seems he does not mind higher risk. If you want the 14% return why wouldn’t you leverage the 12% return fund by shorting the Rfr? that way youd get the same return as the 1st choice, but with a lower std dev due to the lower sharpe ratio of the 2nd fund. my answer is B as well, 1st choice is suboptimal in a risk/return framework. I don’t choose suboptimal choices.

Let’s look at it a different way and assume he as a very low (Or zero) risk aversion factor: Up = Rp - .005(A) (Variance) If A = 0, he would want Mutual Fund A. In fact, the breakeven aversion factor is ~4.2, which is pretty low. I don’t think we can assume shorting is okay, nor do we know what the Rf is. So, I’m going to go against the grain and pick … A.

answer please!

Honestly I don’t think you can really look at the 5 year return/std in this case and make a decision based on that…it’s more a question of the asset allocation characteristics. Consider that his human capital is basically bond-like. Mutual Fund A includes 60% preferred stock, which in my mind is more bond-like than stock-like. Mutual Fund B includes all common stock, with 60% “growth” stock. Theoretically (regardless of the past 5-year results), this should mean that Tony would prefer mutual fund B, because it’s risk/return align better with his personal risk/return/constraints characteristics.

‘C’ - the question does not provide risk free rate, let alone if each of the mutual fund shares same asset class or located in the same country, which means the assumption using Sharpe is inaccurate. The investor clearly willing to take risk, which should be respected, and therefore C is the “appropriate” answer. As for choice ‘A’ using of the Up = Rp - .005(A) (variance), is not appropriate for the question, because the Ques. doesn’t tell you Aversion (is it really 0, or 1 or 2), plus we can’t assume that 5 year return is also EXPECTED return used in investor’s expected utility for the asset mix. As for utilizing a risk free rate to leverage, choice B, would be most appropriate if rf info was available, but it is obviously not in the question. What is the answer anyway HellScream?

i would say B

A high risk fr high return

What’s the answer