An investor decides to invest in the market using his $2 million cash and borrowing additional 30% of his investment. Assuming risk free rate is 4%, market return is 12% with standard deviation of 18% and borrowing rate is 2% higher than the lending rate, the investor's expected return is closest to: Question 66Answera.17.4%b.14.4%c.13.8%
Question
An investor decides to invest in the market using his $2 million cash and borrowing additional 30% of his investment. Assuming risk free rate is 4%, market return is 12% with standard deviation of 18% and borrowing rate is 2% higher than the lending rate, the investor's expected return is closest to: Question 66Answera.17.4%b.14.4%c.13.8%
Solution
To solve this problem, we need to follow these steps:
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First, we need to calculate the total investment. The investor is investing his own 2 million + 30% of 2.6 million.
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Next, we need to calculate the expected return from the market. The market return is 12%, so the expected return from the market is 12% of 312,000.
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Then, we need to calculate the cost of borrowing. The borrowing rate is 2% higher than the risk-free rate, so the borrowing rate is 4% + 2% = 6%. The cost of borrowing is 6% of the borrowed amount, which is 30% of 600,000. So, the cost of borrowing is 6% of 36,000.
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Finally, we subtract the cost of borrowing from the expected return from the market to get the investor's expected return. So, the investor's expected return is 36,000 = $276,000.
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To express this as a percentage of the total investment, we divide by the total investment and multiply by 100. So, the investor's expected return is (2.6 million) * 100 = 10.6%.
Therefore, none of the given options (17.4%, 14.4%, 13.8%) are correct. The investor's expected return is closest to 10.6%.
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