Question

Two investment advisers are comparing performance. One averaged a 20% rate of return and the other an 18% rate of return. However, the beta of the first investor was 1.6, whereas that of the second was 1. i) Can you tell which investor was a better selector of individual stocks (aside from the issue of general movements in the market)? ii) If the Treasury bill (T-bill) rate was 7% and the market return during the period was 12%, which investor would be the superior stock selector? iii) What if the T-bill rate was 4% and the market return was 15%?

Answer 1

I) investor who has average 20% rate of return will be better selector of individual stock as he is able to generate higher rate of return which is more than other investor who has only generated at 18% rate of return.

ii) investor who has generated return of 18% would be a better investor when the market moments according to treasury bills and market premium is to be concerned.

Investor A should have generated= 7+1.6(5)= 15%, he has generated 20%

Investor B should have generated = 7+1(5)= 12%, he has generated 18%.

So investor B has clearly outperformed

Iii) investor A = 4+1.6(11)= 21.6%, he generated in actual 20%

Investor B= 4+1(11)= 15%, he generated in actual 15%

Investor B has generated better returns.