Question

Problem 7-03 You are an analyst for a large public pension Fund and you have been assigned the task of evaluating two different external portfolio managers (Yand 2). You consider the following historical average return, standard deviation, and CAPM beta estimates for these two managers over the past five years Portfolio Actual Avg. Return Standard Deviation Beta Manager Y 11.40 1.10 Manager 2 6.30% 8.50% 0.70 Additionally, your estimate for the risk premium for the market portfolio is 4.00 percent and the risk-free rate is currently 4.50 percent. a. For both Manager Y and Manager 2, calculate the expected return using the CAPM. Round your answers to two decimal places Manager : Manager Z: b. Calculate each fund manager's average alpha (ie, actual return minus expected return) over the five-year holding period. Round your answers to two decimal places Manager Y: Manager 2: Choose the correct SML graph. The correct graph is-Sect . Security market Line E(RI) 0121 017 Alpay 0.001 0.001 0.047 021 Trong 2 taon as ao eta

Answer 1

Using CAPM, E(R) = Rf + beta x MRP, where Rf - Risk free rate = 4.5% and MRP - Market Risk Premium = 4%

For Y, E(R) = 4.5% + 1.1 x 4% = 8.90%

For Z, E(R) = 4.5% + 0.7 x 4% = 7.30%

Alpha For Y = 10.60% - 8.90% = 1.70%

Alpha for Z = 6.30% - 7.30% = -1.00%

The correct graph is D. where you can see that when beta = 1, Returns = 4.5% + 4% = 8.5% and Alpha for Y is +ve and that for Z is -ve.