Question

An investment with a 0.4 probability of a 60% profit and a 0.6 probability of a 60% loss, and the fund's fee structure for manager is 2 plus 20%. should a hedge fund manager choose an investment?

Answer 1

Based on the expected value calculation, the investment is expected to yield a negative return, and once the fund's fees are factored in, it becomes even less attractive. Hence, it may not be advisable for the hedge fund manager to choose this investment.

Step-by-step explanation:

When deciding whether a hedge fund manager should choose an investment with a 0.4 probability of a 60% profit and a 0.6 probability of a 60% loss, it's important to calculate the expected value of the investment and consider the fund's fee structure. The fund's fees are 2% plus 20% of profits.

To calculate the expected value (EV), we use the formula:

EV = (Probability of Profit x Amount of Profit) - (Probability of Loss x Amount of Loss)

Let's use the provided probabilities and outcomes:

EV = (0.4 x 60%) - (0.6 x 60%) = 24% - 36% = -12%

After considering the expected value, the investment has a negative expected return. When taking into account the fund's fees, this would further decrease any potential profit or exacerbate any losses. Therefore, it may not be a wise choice for the hedge fund manager to pursue this investment unless there are other strategic reasons to do so.