Question

Two investment advisors are comparing performance. Advisor A averaged a 19% rate of return with beta = 1.5. Advisor B averaged a 16% rate of return with beta = 1. Risk-free rate is 6% and market expected return is 14%. Can you tell which advisor was the superior stock selector?

Answer 1

CAPM

re=r; + 3 * (rm -rf)

Let's find the required rate of return for both the Advisors. If the average return is greater than the required rate of return, then that advisor is the superior stock selector.

Advisor A (Average return = 19%)

re = 0.06 +1.5 * (0.14 - 0.06)

Te = 0.18

re = 18%

Advisor B (Average return = 14%)

re= 0.06 +1*(0.14 - 0.06)

Te = 0.14

re = 14%

Advisor A: Average return > required return

Advisor B: Average return = Required return

Advisor A is the superior stock selector.

Can you please upvote? Thank You :-)