Question

You are provided with information on mutual fund performance. All Funds have an investment objective of outperforming the S&P 500 Index (symbol: SPX). None of the MFs distribute dividends to their investors.

[Table 2] Mutual Fund Performance (Year 2019: 12/31/2018-12/31/2019)

	Average number of stocks in 2019	Price as of 12/31/2018	Price as of 12/31/2019	Annual risk (stdev)	market risk ()
MF A	500	100	128	30%	1.00
MF B	125	100	130	30%	1.05
MF C	12	100	100	40%	1.40
MF D	46	100	95	25%	0.90

In 2019, S&P 500 Index gained 28% (total return); the annual risk-free rate is 2%.

Questions:

1. (5 pts) Which one mutual fund has a negative total rate of return in 2019?
2. (5 pts) Which one mutual fund most likely an S&P 500 Index Fund?
3. (5 pts) Which one mutual fund is least diversified?
4. (5 pts) Based on the Capital Asset Pricing Model (CAPM), which mutual fund should have the highest required rate of return in 2019?
5. (10 pts) Based on the CAPM, which mutual fund performed the best in 2019?

Answer 1

A]

MF D has a negative total rate of return in 2019 because the Price as of 12/31/2019 is lower than the Price as of 12/31/2018

B]

MF A is most likely an S&P 500 Index Fund because its beta (market risk) equals 1.

Beta is a measure of the sensitivity of the asset to the overall market. The market portfolio (S&P 500) has a beta of 1.  

C]

MF C is the least diversified as it has the lowest average number of stocks

D]

CAPM required return = risk free rate + (beta * market risk premium)

The risk free rate and market risk premium are the same for all the funds. Therefore, the fund with the highest beta (market risk) should have the highest required return

MF C  should have the highest required rate of return in 2019