Ophelia is considering the purchase of the Quest Mutual Fund, which has a beta of 1.2, standard deviation of 15, and a return of 11%. Should Ophelia purchase the fund?

Ophelia is considering the purchase of the Quest Mutual Fund, which has a beta of 1.2, standard deviation of 15, and a return of 11%. Should Ophelia purchase the fund?

• A. No, because the fund has a negative alpha.
• B. Yes, because the fund has an 11% return.
• C. Yes, because of the fund's Treynor ratio.
• D. No, because of the fund's Sharpe ratio.

Answer: (A)

In evaluating whether Ophelia should purchase the Quest Mutual Fund, an important factor to consider is the fund's alpha, which indicates how much the fund is expected to outperform or underperform its benchmark, considering its level of risk. A negative alpha suggests that the fund is not generating excess returns relative to its risk, which signifies that it may not be a suitable investment choice. By focusing on the concept of alpha, a negative value indicates that, after adjusting for systematic risk (as illustrated by its beta), the fund's return is not justified. For an investor like Ophelia, who is likely seeking to achieve returns that compensate her for the risk taken, choosing a fund with a negative alpha would be counterproductive to her investment objectives. While the fund's return of 11% may seem appealing, if that return does not adequately compensate for the risk taken (as indicated by a negative alpha), then it does not warrant investment. This aligns with the understanding that the goal of investment is to achieve a return that exceeds that warranted by the assumed risk. Therefore, considering the situation to make an informed decision, a negative alpha is a decisive factor against purchasing the fund.

In evaluating whether Ophelia should purchase the Quest Mutual Fund, an important factor to consider is the fund's alpha, which indicates how much the fund is expected to outperform or underperform its benchmark, considering its level of risk. A negative alpha suggests that the fund is not generating excess returns relative to its risk, which signifies that it may not be a suitable investment choice.

By focusing on the concept of alpha, a negative value indicates that, after adjusting for systematic risk (as illustrated by its beta), the fund's return is not justified. For an investor like Ophelia, who is likely seeking to achieve returns that compensate her for the risk taken, choosing a fund with a negative alpha would be counterproductive to her investment objectives.

While the fund's return of 11% may seem appealing, if that return does not adequately compensate for the risk taken (as indicated by a negative alpha), then it does not warrant investment. This aligns with the understanding that the goal of investment is to achieve a return that exceeds that warranted by the assumed risk. Therefore, considering the situation to make an informed decision, a negative alpha is a decisive factor against purchasing the fund.