Question

Consider the two empirical models for excess returns (Ri-Rf) of stocks A and B. The risk...

Consider the two empirical models for excess returns (Ri-Rf) of stocks A and B. The risk free rate (Rf) over the period was 6%, and the market’s average return (Rm) was 14%.

Stock A

Stock B

Estimated market models

Ri-Rf= 1% + 1.2(Rm – Rf)

Ri-Rf = 2% + 0.8(Rm – Rf)

Standard deviation of excess returns

21.6%

24.9%

Find the following for each stock:

  1. Alpha
  2. Sharpe ratio
  3. Treynor ratio
  4. b) Based on your answers to part a), which stock is the best choice under the following circumstances?
  5. This is the only risky asset to be held by the investor.
  6. This is one of many stocks that the investors is analysing to form an actively managed stock portfolio.
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