Question

Two investment advisers are comparing performance. One averaged a 19% return and the other a 16% return. However, the beta of the first adviser was 1.5, while that of the second was 1.a. Can you tell which adviser was a better selector of individual stocks (aside from the issue of general movements in the market)?O First Investment AdvisorO Second Investment AdvisorO Cannot be determinedb. If the T-bill rate were 6% and the market return during the period were 14%, which adviser would be the superior stock selector?O First Investment AdvisorO Second Investment AdvisorO Cannot be determinedc. What if the T-bill rate were 3% and the market return 15%?O First Investment AdvisorO Second Investment AdvisorO Cannot be determined

Answer 1

Answer (A):

Need more data to select the better adviser

Explanation:

Adviser A averaged 19% return on the investment which is more than that of Adviser B who averaged 16% return on investment. However, adviser A has a beta of 1.5 which is also greater than that of Adviser B who has a beta of 1. This means that adviser A made a more riskier investment and hence a higher average return on investment. We need more data to tell which adviser performed better in relation to each other.

Answer (B):

Investment Adviser B

Step-by-step explanation:

`R_(f)` = T-bill rate = 6%

`R_(m)` = Market return = 14%

`R_(m) - R_(f)` = Market risk premium = 14% - 6% = 8%

`ER_(a)` = Average Return by Adviser A =19%

`\beta _(a)` = Beta of Adviser A = 1.5

`ER_(b)` = Average Return by Adviser B =16%

`\beta _(b)` = Beta of Adviser B = 1

CAPM Equation is
`ER_(i) = R_(f) +\beta (R_(m) - R_(f) ) +\alpha`

For Adviser A

`ER_(i)` = 6 + 1.5 (14 - 6) = 18%

The expected average return for the investment is 18% which means that Adviser A over performed the market by 1 %

For Adviser B

`ER_(i)` = 6 + 1 (14 - 6) = 14%

The expected average return for the investment is 14% which means that the Adviser B over performed the market by 2 %

Clearly, Adviser B performed better than Adviser A.

Answer (C):

Adviser B

Step-by-step explanation:

In this part, the
`R_(f) = 3 %` and
`R_(m) = 15%`

All else remains the same

We make similar calculation as in part B