Question

Two investment advisers are comparing performance. One averaged a 15.75% rate of return and the other a 19% 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) =15.75%

alpha1 = 15.75%-(3%+1.5*(15%-3%)) = -5.25%

alpha2 = 19%-(3%+1*(15%-3%)) = 4.00%

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