Reference no: EM132959266

Question - Friend Investments (FI) is an actively managed equity fund. Over the past three years, FI has earned an average annual return of 23.3% before management costs. The average annual return on the market index over the same period was 6.6% and average annual risk-free return 0.4%.

FI is classified as a high risk fund whose annual variance of returns is 0.2457, compared to a market annual variance of 0.0241. The correlation coefficient between FI and market returns is 0.6188.

Required -

a) Calculate FI's beta value and use the Capital Asset Pricing Model to produce an expected annual return for FI. Comment on the relation between FI's actual and expected annual return.

b) Calculate the Sharpe ratio, the Treynor ratio for FI and the market, together the Jensen alpha for FI. Use the results to assess the performance of FI given that it is an actively managed fund.

c) Undertake a Fama decomposition of FI's return and make a leveraged investment in the market portfolio that replicates the risk of FI. Discuss the extent to which FI's performance can be explained by fund management skills.

d) With reference to FI's performance over the last three years, analyze the idea that investors ought to seek fund managers who have a track record of positive alpha returns.