Question

Two investment advisers are comparing performance. One averaged a 16.45% rate of return and the other a 19.78% 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

According to CAPM Estimated Return = Risk Free Return + Beta*(Market Risk Premium)

Now for Advisor 1 Estimated return = 3% + 1.5*(15-3) = 21%

and for Advisor 2   Estimated return = 3% + 1*(15-3) = 15%

whereas the actual return = Advisor 1 = 16.5% and advisor 2 = 19.78%

So Advior 1 portfolio is inferior as actual return < estimated return and Advior 2 portfolio is isuperior as actual return > estimated return.

The djfference is = 21% - 16.45% = -4.55% and for B = 19.78% - 15% = 4.78%

Difference between two portfolio is = 19.78 - 16.45 = 3.33%