You estimate that a passive portfolio which mimics the S&P 500 yields an expected annual return of 13% with a standard deviation of 25%. You also manage an active portfolio with an expected annual return of 18% and standard deviation of 28%. The risk-free rate is 8%.
a. Draw the CML for the passive portfolio and the CAL for your active portfolio on an expected return-standard deviation diagram. What are the slopes for the two lines?
b. What is the maximum fee you could charge (as a percentage of the investment in your fund, deducted at the end of the year) that would leave a client as well off investing in your active portfolio as in the passive portfolio. (Hint: The fee will lower the slope of the CAL by reducing the expected return net of the fee.)