Question

You are considering the risk-return profile of two mutual funds for investment. The relatively risky fund promises an expected return of 7% with a standard deviation of of 13%. The relatively less risky fund promises an expected return and standard deviation of 4.5% and 5.2%, respectively. Assume that the returns are approximately normally distributed.

a. Which mutual fund will you pick if your objective is to minimize the probability of earning a negative return?

b. Which mutual fund will you pick if your objective is to maximize the probability of earning a return above 9%?

Answer 1

A.

Mutual fund to pick if your objective is to minimize the probability of earning a negative return then choose the MF which doent give higher negative return.

Lets see, MFa = 7 - 13 = -6% and MFb = 4.5-5.2% = -0.7% return. we choose Mutual Fund 2nd because it has lesser negative return ( only -0.7% compared to -6% of the 1st MF)

Choose 2nd MF.

B.

To maximize above 9% we choose first MF because it given 7+13% or 20% return and 2nd MF gives just 4.5+5.2% or 9.7% or just 0.7 % above 9% return whereas the 1st one' giving 11% on top of 9% return.

Choose 1st MF for this.