Question

Two investment advisers are comparing performance. One averaged a 16.45% rate of return and the other a 20.98% 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

Risk free rate of return would be taken ofreturn of treasury bills because they are deemed to be risk free Assets and they are to be incorporated while calculation of Capital Asset pricing model expected rate of return.

Expected rate of return of investor A= Rf+Beta (Rm-Rf)

= 3+1.5(15-3)

= 3+18

= 21%

Expected rate of return of investor B

= 3+1(15-3)

= 15%

It can be seen that investor A has generated return of 20.98% where as investor B has generated a return of 16.45%.

So,it can be said that investor A has underperformed the expectation of the market and investor B has outperformed thethe expectation of the market.