Question

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

Answer 1

Answer:

Based on the results, Adviser A's choice of stocks yielded a greater excess return. Thus, he was a better stock picker.

Adviser A's excess return = 3%

Adviser B's excess return = 0.04%  

Explanation:

To compare the performance of the two stock advisers, we first need to determine the required or expected rate of return of both the portfolios.

Using the CAPM, we can calculate the expected rate of return for each portfolio.

The equation for CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

• rRF is the risk free rate
• rM is the return on market

Adviser A

r = 0.05 + 1.5 * (0.13 - 0.05)

r = 0.17 or 17%

The required rate of return of Adviser A's portfolio was 17% while his portfolio yielded a return of 20% on average. The excess return on the portfolio was 20 - 17 = 3%

Adviser B

r = 0.05 + 1.2 * (0.13 - 0.05)

r = 0.146 or 14.6%

The required rate of return of Adviser B's portfolio was 14.6% while his portfolio yielded a return of 15% on average. The excess return on the portfolio was 15 - 14.6 = 0.04%

Based on the results, Adviser A's choice of stocks yielded a greater excess return. Thus, he was a better stock picker.