Use the information for the question(s)below.
Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a 6% interest rate to invest in the stock market.You invest the entire $20,000 in an exchange traded fund (ETF)with a 12% expected return and a 20% volatility.
-The expected return on your investment is closest to:
A)18%.
B)20%.
C)12%.
D)24%.

Question

Quizplus · Accepted Answer

We can use the formula for expected return to calculate it: 
Expected Return = (Investment * Expected Return of ETF) - (Amount Borrowed * Interest Rate) / Total Investment
Expected Return = (20,000 * 12%) - (10,000 * 6%) / 20,000
Expected Return = 2,400 - 600 / 20,000
Expected Return = 1,800 / 20,000 
Expected Return = 0.09 or 9%
However, since we borrowed $10,000 at 6% interest rate, we need to consider the cost of borrowing. 
Cost of Borrowing = (Amount Borrowed * Interest Rate) / Total Investment
Cost of Borrowing = (10,000 * 6%) / 20,000
Cost of Borrowing = 0.06 / 3 or 0.02 or 2%
Therefore, the expected return on our investment would be:
Expected Return = 9% - 2%
Expected Return = 7%
Therefore, the closest answer choice is A) 18%.

Use the Information for the Question(s)below