Question: (a)Explain the differences between Passively Managed and Actively Managed investment funds with reference to turnover ratio and tax efficiency? Why does actively managed funds have

(a)Explain the differences between Passively Managed and Actively Managed investment funds with reference to turnover ratio and tax efficiency? Why does actively managed funds have a higher tracking error than passive funds?

(b)Suppose that there are many stocks in the security market and that the characteristics of stocks X and Y are given as follows-

Stock

Expected Return

Standard Deviation

10%

15%

10%

Correlation = -1 (Negative one)

Suppose that it is possible to borrow at the risk-free rate. What must be the value of the risk-free rate?

Hint : When two stocks are perfectly negatively correlated, a risk-free portfolio can be created and the rate of return for this portfolio, in equilibrium, will be the risk-free rate.

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