Consider the following information on 3 mutual finds Fund1 Fund 2 Fund 3 Mean 0.45 0.35 0.10 Volatility 0.8 0.50 0.10 If the risk free is 5%, which one of these could be the market portfolio? a. Fund1 b. Fund2 c. Fund3 d. Can’t tell
Hmmm I am very unsure about this. The only thing that I could see to calculate based on this is the Sharpe ratio (which is also the slope of the CML I think?) It should be high for the one that’s actually the market portfolio given that it is the best combination of risky assets (ie best return per unit of risk). Based on that logic, the answer is B. But I have no idea if this is on the right track. Anyone?
My original thought is that it is fund C because it is perfectly efficient at 0.1/0.1
pick the one with the highest sharpe ratio. B has Sharpe ratio of (0.35-0.05)/0.3=0.6 > (0.45-0.05)/0.8 = 0.5 of fund A and (0.1-0.05)/0.05=0.5 of fund C. the answer is B.
Good one Kiakaha… I would have never arrived at it… Now that you mention it, I guess the tangent will have the highest slope giving maximum return per unit risk … i.e. sharpe ratio…
Thanks anish, lucky guess Also it’s worth pointing out we won’t get any questions like this on the exam, CFAI has a policy of not using answer options like ‘all of the above’/‘none of the above’/‘not enough info to tell’ etc: www.cfainstitute.org/cfaprogram/exams/format/Pages/cfa_exam_question_formats.aspx
Say Kiakaha, is there some mail id where I could reach you? I have a question on Sharpe Ratio… I think I am sorely missing some point… If you would rather not share, I would understand…
Hey anish – sure-- kiakaha4 (at) gmail.com No guarantees I can help but will try