You are evaluating two investment alternatives (to be your only investment along with riskfree assets). One is a passive market portfolio with an expected return of 10% and a standard deviation of 16%. The other is a fund that is actively managed by your broker, has an expected return of 15% (before fees) and a standard deviation of 20%. The risk-free rate is
Currently 6%.
a. What is the maximum fee your broker could charge and still leave you as well off as if you had invested in the passive market fund? (Assume that the fee would be a percentage of the investment in the broker’s fund, and would be deducted at the end of the year.)
b. How would it affect your decision if you wished to invest only 50% of your funds in the risky portfolio (either the broker’s or the index)?What is the R2 for firm A?