Problem 20 Two investment advisers are comparing performance. Adviser A averaged
ID: 2748934 • Letter: P
Question
Problem 20
Two investment advisers are comparing performance. Adviser A averaged a 20% return with
a portfolio beta of 1.5, and adviser B averaged a 15% return with a portfolio beta of 1.2. If the T-bill rate
was 5% and the market return during the period was 13%, which adviser was the better stock picker?
A. Advisor A was better because he generated a larger alpha.
B. Advisor B was better because she generated a larger alpha.
C. Advisor A was better because he generated a higher return.
D. Advisor B was better because she achieved a good return with a lower beta
the answer is A but could you explain
Explanation / Answer
Comparision between two managers can be done by standardising their return, Jenson's Alpha can be used as a measure.
Jenson's Alpha = Portfolio Actual Return - Benchmark Portfolio Return (CAPM)
Given, Risk Free Rate = 5%
E(Rm) = 13%
Beta of Adviser A = 1.5
Beta of Adviser B = 1.2
Benchmark Portfolio = 5 + 1.2 (13-5)
= 14.6%
Therefore, Advisor A is better because he generated a larger alpha of 3% compared to B who created only 0.4%.
Advisers CAPM = Risk free return + Beta ( E(Rm) - Risk free return) Actual Return Jenson's Alpha A Benchmark Portfolio = 5 + 1.5 (13-5)= 17% 20% 20-17 = 3% B
Benchmark Portfolio = 5 + 1.2 (13-5)
= 14.6%
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