Question

Two investment professionals are comparing their return performance. The first professional managed portfolios with an average...

Two investment professionals are comparing their return performance. The first professional managed portfolios with an average return of 10% and the second professional managed portfolios with a 12% rate of return. The beta of the first portfolio was 0.8 while the beta of the second was 1.1. The risk-free rate of return was 2% and the expected market return is 8%.
A. [5 points] Which manager was a better selector of individual stocks, and why?

B. [2 points] Plot both of the portfolios on the security market line.

Homework Answers

Answer #1

First we can find expected return using CAPM formula

Expected return = Risk free rate of return + beta(expected market return - Risk free return)

For first professional expected return was = 2% + 0.8(8%-2%)

=2% + 0.8(6%)

=2%+4.8% = 6.8%

For Second professional expected return was =

2% + 1.1(8%-2%)

=2% + 1.1(6%)

=2%+6.6% = 8.6%

Now First professional offered 3.2% excess return over expected return ( 10%-6.8%)

While Second professional offered 3.4% excess return over expected return (12%-8.6%)

Thus Second professional was better selector of individual stock

B)

SLM Line - Graph

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