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Suppose that the borrowing rate that your client faces is 11%
Suppose that the borrowing rate that your client faces is 11%. Assume that the S&P 500 index has an expected return of 13% and standard deviation of 25%. Also assume that the risk-free rate is rf = 4%. Your fund manages a risky portfolio, with the following details: E(rp) = 15%, standard deviation = 22%. What is the largest percentage fee that a client who currently is lending (y < 1) will be willing to pay to invest in your fund? What about a client who is borrowing (y > 1)?
Expert Solution
Computation of the largest percentage fee:-
Client who is currently lending ;
((Market return-Risk free rate)/Market standard deviation) = ((Portfolio return-Risk free rate-Fee)/Portfolio standard deviation)
((13% - 4%) / 25%) = ((15% - 4% - Fee) / 22%)
36% * 22% = 11% - Fee
7.92% = 11% - Fee
Fee = 11% - 7.92%
= 3.08%
Client who is currently borrowing ;
((Market return-Borrowing rate)/Market standard deviation) = ((Portfolio return-Borrowing rate-Fee)/Portfolio standard deviation)
((13% - 11%) / 25%) = ((15% - 11% - Fee) / 22%)
8% * 22% = 4% - Fee
Fee = 4% - 1.76%
= 2.24%
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