Question

Fidelity large cap fund has a Sharp ratio of 0.7 and expected return of 18%. Fidelity small cap has a Sharpe ratio of 0.5 and expected return of 20%. Which fund should a risk-averse investor prefer if he/she likes to construct a portfolio using the risk-free and one of the funds?

		A)           Fidelity small cap
		B)            Fidelity large cap
		C)            Allocate 50% to each funds
		D)           Only risk free asset
		E)            None of the above

Answer 1

Correct Answer. B - Fidelity Large cap fund

A risk averse investor will always choose less risky investments for same return offered by the funds in consideration. Since Sharpe ratio (reward - to - risk) is higher for Fidelity Large cap Fund (0.7) and lower for Fidelity Small Cap Fund (0.5), hence the investor will choose the fund which has higher return for same risk or lower risk for same return.

Therefore, preferred combination is (risk free asset + Fidelity Large cap fund)