Question

two investment advisers are comparing performance. One averaged a 16.27% rate of return and the other a 20.51% 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 1

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Answer:

The abnormal return can be determined as ,

For Investor 1 , A(R) =16.27%

alpha1 = 16.27%-(3%+1.5*(15%-3%)) = -4.73%

alpha2 = 20.51%-(3%+1*(15%-3%)) = 5.51%

Here, the second investor has the larger abnormal return (Alpha value) and thus appears to be the superior stock selector.

The first stock is the inferior stock as it has a negative abnormal return