Two investment advisers are comparing performance. One averaged a 15% rate of re
ID: 2736538 • Letter: T
Question
Two investment advisers are comparing performance. One averaged a 15% rate of return and the other a 12% rate of return. However, the beta of the first investor was 1.7, whereas that of the second was 1.
1. Can you tell which investor was a better selector of individual stocks (aside from the issue of general movements in the market)? And Why?
2. If the T-bill rate were 8% and the market return during the period were 8%, which investor would be the superior stock selector?
3. If the T-bill rate were 5% and the market return during the period were 11%, which investor would be the superior stock selector?
Explanation / Answer
1.
Compare the advisor is understanding return to what the return should have been according the CAPM. The difference is the advisors .
A positive designate a positive risk – adjusted abnormal return: after accurate for market risk, the advisor ‘beat the market’.
A negative specify a negative risk – adjusted abnormal return: after correcting for market risk, the advisor dis not ‘ beat the market’.
2.
E(r1) = rf + 1 [E(rM)-rf]
= 0.08 + 1.7 [0.08-0.08]
=0.08 or 8%.
Realized r1 = 15%
() 1 = 15% -8% = 7%
Risk adjusted excess return is 7%
E(r2) = rf + 1 [E(rM)-rf]
= 0.08 + 1. [0.08-0.08]
=0.08 or 8%.
Realized r2 = 12%
() 2 = 12% -8% = 4%
Risk adjusted excess return is 4%
3.
E(r1) = rf + 1 [E(rM)-rf]
= 0.05 + 1.7 [0.11-0.05]
= 0.05 + 0.102
=0.152 or 15.20%.
Realized r1 = 15%
() 1 = 15% -15.20% = -0.20%
Risk adjusted excess return is -0.20%
E(r2) = rf + 1 [E(rM)-rf]
= 0.05 + 1. [0.11-0.05]
=0.05+0.06
=0.11 or 11%.
Realized r2 = 12%
() 2 = 12% -11% = 1%
Risk adjusted excess return is 1%
1.
Compare the advisor is understanding return to what the return should have been according the CAPM. The difference is the advisors .
A positive designate a positive risk – adjusted abnormal return: after accurate for market risk, the advisor ‘beat the market’.
A negative specify a negative risk – adjusted abnormal return: after correcting for market risk, the advisor dis not ‘ beat the market’.
2.
E(r1) = rf + 1 [E(rM)-rf]
= 0.08 + 1.7 [0.08-0.08]
=0.08 or 8%.
Realized r1 = 15%
() 1 = 15% -8% = 7%
Risk adjusted excess return is 7%
E(r2) = rf + 1 [E(rM)-rf]
= 0.08 + 1. [0.08-0.08]
=0.08 or 8%.
Realized r2 = 12%
() 2 = 12% -8% = 4%
Risk adjusted excess return is 4%
3.
E(r1) = rf + 1 [E(rM)-rf]
= 0.05 + 1.7 [0.11-0.05]
= 0.05 + 0.102
=0.152 or 15.20%.
Realized r1 = 15%
() 1 = 15% -15.20% = -0.20%
Risk adjusted excess return is -0.20%
E(r2) = rf + 1 [E(rM)-rf]
= 0.05 + 1. [0.11-0.05]
=0.05+0.06
=0.11 or 11%.
Realized r2 = 12%
() 2 = 12% -11% = 1%
Risk adjusted excess return is 1%
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