18 - A mutual fund with a beta of 0.75 does not mean that...

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Suppose that a mutual fund has a beta equal to 0.75. Is it necessarily the case that the standard deviation of returns on the fund is less than the standard deviation of market returns? A mutual fund is a type of an investment company that pools money from many investors and invests the money in stocks, bonds, money-market instruments, other securities, or even cash The reason why most mutual funds usually provide greater returns over time than guaranteed investments is because of the risk premium rewarded to investors. This premium comes in the form of higher returns associated with accepting market risk, which is the risk of losing some portion or the entire original amount invested. The beta coefficient is a measure of a stock’s market risk, or the extent to which the returns on a given stock move with the stock market. The average stock’s beta would move on average with the market so it would have a beta of 1.0.
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Unformatted text preview: A mutual fund with a beta of 0.75 does not mean that its standard deviation of returns is lower than of the market returns as there are other factors that are involved in the volatility of a fund. Those are systematic and unsystematic risk. The beta of this mutual fund indicates that the mutual funds systematic risk is less than the markets systematic risk (that is, the beta is less than 1.0). However, this mutual fund may not be well diversified. For example, it may be a fund that holds only securities in a specific industry or sector. In that case, the mutual fund will have both systematic and unsystematic risk, while the market by definition has only systematic risk. The standard deviation of this fund will reflect the sum of both types of risk. If the level of unsystematic risk in the fund is high enough, then the funds total risk (standard deviation) may be higher than the markets total risk....
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This note was uploaded on 10/15/2011 for the course FIN 550 taught by Professor Smith during the Spring '11 term at Berklee.

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