Question

Assume the risk-free rate is 4%. You are a financial advisor, and must choose one of the funds below to recommend to each of your clients. Whichever fund you recommend, your clients will then combine it with risk-free borrowing and lending depending on their desired level of risk.
Expected Return Volatility
Fund A 10% 10%
Fund B 15% 22%
Fund C 6% 2%

Required:
a. Which fund would you recommend to a client seeking the highest possible expected return with a maximum volatility of 22%?
b. Which fund would you recommend to a client seeking the highest possible expected return with a maximum volatility of 22%?
c. Which fund would your recommend without knowing your clients risk preference?

Answer 1

Answer:

Following are the solution to the given point.

Explanation:

Calculate each fund's Sharpe ratio. It Fund is the best danger reward with the highest Sharpe ratio.

$\text{Sharpe Ratio} = \frac{\text{(Fund return - \text{risk free return)}}}{Volatility}\\\\\to Fund A= \frac{(10\%-4\%)}{10\%} = 0.6\\\\\to Fund B= \frac{(15\%-4\%)}{22\%} = 0.5\\\\\to Fund C = \frac{(6\%-4\%)}{2\%}=1.0$

Fund C consequently offers the best risk-benefit. and without understanding client risk preference, we will advise Fund C for any clients. If a client wants to have a 22 percent minimum volatility, we'll nevertheless propose that Fund C instead of Fund B is available, because an investor can take risk-free rates to the degree that the total portfolio volatility stands at 22 percent and deposit it in Fund C.