Question

) Two investment advisers are comparing performance. One averaged a 20% rate of return and the other an 18% rate of return. However, the beta of the first investor was 1.6, whereas that of the second was 1. i) Can you tell which investor was a better selector of individual stocks (aside from the issue of general movements in the market)? ii) If the Treasury bill (T-bill) rate was 7% and the market return during the period was 12%, which investor would be the superior stock selector? iii) What if the T-bill rate was 4% and the market return was 15%?

Answer 1

Answer :

(i) In this case it is not possible to say as to which investor was the better selector of individual stocks. Since in this part information such as Risk free Rate. Return from market which are required to compare actual Return from Expected return are absent , therefore we are not able to determine which investor was a better selector of individual stocks.

(ii) Excess Return = Actual Return - Expected Return

First Adviser

Actual Return = 20%

Expected Return = Risk free rate + Beta * ( Return from Market - Risk free rate)

= 7% + 1.6 * (12% - 7%)

= 7 % + 8%

= 15%

Excess Return = 20% - 15%

= 5%

Second Adviser

Actual Return = 18%

Expected Return = Risk free rate + Beta * ( Return from Market - Risk free rate)

= 7% + 1 * (12% - 7%)

= 7 % + 5%

= 12%

Excess Return = 18% - 12%

= 6%

Second Adviser has highest Excess return therefore he is superior stock selector

(iii)

First Adviser

Actual Return = 20%

Expected Return = Risk free rate + Beta * ( Return from Market - Risk free rate)

= 4% + 1.6 * (15% - 4%)

= 4 % + 17.6%

=21.6%

Excess Return = 20% - 21.6%

= (-1.6%)

Second Adviser

Actual Return = 18%

Expected Return = Risk free rate + Beta * ( Return from Market - Risk free rate)

= 4% + 1 * (15% - 4%)

= 4 % + 11%

=15%

Excess Return = 18% - 15%

= 3%

Second Adviser has highest Excess return therefore he is superior stock selector