Question

Correlating Market Performance

1. Imagine that you have to invest in ONE of the following two funds:
   1. Fund BIOTECH with the following performance: Down 50% in Year 1, Up 60% in Year 2. Average arithmetic return is 5% per year with higher than average volatility that is expected to persist in the future.
   2. Fund UTILITIES with the following performance: Down 1% in Year 1, Up 2% in Year 2. The average return is 0.5% with lower than average volatility that is expected to persist in the future.
   3. Based on your analysis of the two funds' performance and riskiness, which fund would you select and why?

200 words minimum.

Answer 1

To select the bets fund among the two alternatives, we need to calculate return to risk ratio. The caulculations are shown in the table below. To calculate return to risk ratio, average return is calculated by adding the performance of two years and dividing it by two (same process as arithmetic mean). The average return for year fund biotech  returns as 5% and fund utilities as 0.50%. Return to risk ratio is calculated by dividing average return with standard deviation. The return to risk ratio is 0.06 for fund biotech and 0.24 for fund utilities.

	Fund Biotech	Fund Utilities
year 1	-50%	-1%
year 2	60%	2%
Standard deviation	77.78%	2.12%
Average Return	5%	0.50%
Return/Risk	0.06	0.24

Since the return is higher for fund utilities, the best alternative is fund utilities