Question

Two investment advisers are comparing performance. One averaged a 16.34% rate of return and the other a 20.69% rate of return. However, the β of the first investor was 1.5, whereas that of the second investor was 1.

Required: Suppose that the T-bill rate was 3% and the market return during the period was 15%. Aside from the issue of general movements in the market, outline the difference between the superior and inferior portfolios.

Answer% Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places (for example: 28.31%)

Answer 1

Solution :-

To Judge Superior and inferior portfolio

We need to Calculate difference of Average return and Expected Return

First Investor

Average Return = 16.34%

Expected Return = Rf + Beta * ( Rm - Rf ) = 3% + 1.50 * ( 15% - 3% ) = 21%

Second Investor

Average Return = 20.69%

Expected Return = Rf + Beta * ( Rm - Rf ) = 3% + 1.00 * ( 15% - 3% ) = 15%

Now Abnormal Return ( Alpha ) of

First Investor = Average Return - Expected Return = 16.34% - 21% = - 4.66%

Second Investor = Average Return - Expected Return = 20.69% - 15% = 5.69%

Second Investor has Superior Performer

A superior portfolio is one which has generated excess returns over the required return and has lower beta.

Difference =

Alpha = 5.69% - ( - 4.66% ) = 10.35%

Expected Returns = 15% - 21% = - 6%

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