Mini-Case Larry Lynch has been working for a year as an analyst for an The investment company began putting together sales ir: investment company that specializes in serving very wealthy formation concerning the possible performance of the new func clients. These clients often purchase shares in closely held and has made the following predictions regarding the possibh investment funds with very limited numbers of stockholders. In performance of the new fund over the coming year as a functio! the fall of 2008, the market for certain types of securities based of how well the economy does: on real estate loans simply collapsed as the subprime mortgage scandal unfolded. Larry's firm, however, sees this market col- State of the Economy Probability Fund Return lapse as an opportunity to put together a fund that purchases Rapid expansion 10% 50% some of these mortgage-backed securities that investors have Modest growth 50% 35% shunned by acquiring them at bargain prices and holding them No growth 40% 5% until the underlying mortgages are repaid or the market for these Recession 5% -100% securities recovers. ing issues: Larry's boss has asked him to perform a preliminary analy- In addition to the information provided above. Larry has sis of the new fund's performance potential for the coming year. observed that the risk-free rate of interest for the coming year is Specifically, he has asked that Larry address each of the follow- 4.5 percent, the market risk premium is 5.5 percent, and the beta for the new investment is 3.55. 1. What are the expected rate of return and standard deviation? Based on your analysis, do you think that the proposed fund offers a fair return given its risk? Explain. 2 What is the reward-to-risk ratio for the fund based on the fund's standard deviation as a measure of risk? 3. What is the expected rate of return for the fund based on the Capital Asset Pricing Model