Question
You are trying to evaluate two different assets - an S&P 500 index fund with an expected return of 8% and a standard deviation of
You are trying to evaluate two different assets - an S&P 500 index fund with an expected return of 8% and a standard deviation of 18%, and a mutual fund with an expected return of 11% and a standard deviation of 27%. The risk-free rate is 2%.
You friend has recently read an article in Zero Hedge alleging that the mutual fund is actually just a levered up version of the S&P 500 fund, taking investors' money, borrowing more at the risk free rate, and investing all of it in S&P 500 index funds. You want to investigate this claim.
A. Explain how, under the Capital Allocation Line, you can use the Sharpe Ratio to test if the mutual fund looks like a levered up version of the S&P 500 fund.
B. Does the fund look like it might be a levered up version of the S&P 500, or not? Please explain your reasoning.
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