Question

Davita Spencer is a manager at Half Dome Asset Management. She can generate an alpha of 2% a year up to $100 million. After that her skills are spread too thin, so she cannot add value, and her alpha is zero. Half Dome charges a fee of 1% per year on the total amount of money under management (at the beginning of each year). Assume that there are always investors looking for positive alpha and no investor would invest in a fund with a negative alpha. In equilibrium, that is, when no investor either takes out money or wishes to invest new money, a.What alpha do investors in Davita’s fund expect to receive? b.How much money will Davita have under management? c.How much money will Half Dome generate in fee income?

Answer 1

a. Zero

b. $200 million

c. $2 million

Step-by-step explanation:

a. The investor invest regular in portfolio with the positive alpha until the portfolio size has driven alpha to zero.

b. Davita return 2% of $100 million = $2 million

1% fee \times X million total under management.

Than, X = $200 million

c. $200 million \times 1% fee given = $2 million