Question

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 5.5%. The probability distributions of the risky funds are:

	Expected return	Standard Deviation
Stock Fund (S)	15%	32%
Bond Fund (B)	9	23

The correlation between the fund returns is .15.

What is the reward-to-volatility ratio of the best feasible CAL?

Short answer

0.3154

Step-by-step solution

Definition

A performance metric to determine the extent of excess return generated for the risk taken by the portfolio is known as the reward to volatility ratio.

Calculation of reward to volatility ratio

The formulae for reward to volatility ratio is: E(r_P - r_F)/σ_P

= 13.25 – 5.5 / 24.57

= 0.3154