Share
Explore BrainMass

# ROR fund must earn to make better off in fund than in bankCD

You are considering investing in a mutual fund with a front-end load of 5% and an annual expense of 0.6%. You could also invest in a bank CD paying 6.5% per year. If you plan to invest for two years, what minimum annual rate of return must the fund earn to make you better off in the fund than in the CD?

a) 6.50%
b) 8.69%
c) 8.78%
d) 9.87%

#### Solution Preview

You are considering investing in a mutual fund with a front-end load of 5% and an annual expense of 0.6%. You could also invest in a bank CD paying 6.5% per year. If you plan to invest for two years, what minimum annual rate of return must the fund earn to make you better off in the fund than in the CD?

a) 6.50%
b) 8.69%
c) 8.78%
d) 9.87%

#### Solution Summary

The minimum annual rate of return that the fund must earn to make you better off in the fund than in the CD is:
d) 9.87%

Let the investment amount be \$100

If the investment is made in a bank CD paying 6.5% per year, the value at the end of 2nd year will be:

Investment \$100.00
n 2.00 years
Rate of return 6.50%
Terminal value \$113.42

In a mutual fund, the initial investment will be \$95 (\$100 minus 5% front-end load).
An investment of \$95 to grow to \$113.42 (equivalent to return from bank CD) must earn:

Investment \$95.00
n 2.00 years
Terminal value \$113.42
MIRR* ?

\$ 95.00(1+RR)^2 = \$ 113.42

MIRR = ((\$113.42/\$95.00)^(1/2)) - 1
MIRR = 0.0927
MIRR = 9.27%

* Modified Internal rate of return

The mutual fund also has an annual expense of 0.6%. In order to earn a net return of
9.27%, we must add 0.6% to arrive at the gross return that the fund must earn which is 9.87%

\$2.19