You are an analyst for a large public pension fund and you have been assigned th
ID: 2701649 • Letter: Y
Question
You are an analyst for a large public pension fund and you have been assigned the task of evaluating two different external portfolio managers (Y and Z). You consider the following historical average return, standard deviation, and CAPM beta estimates for these two managers over the past five years:
Additionally, your estimate for the risk premium for the market portfolio is 5.00 percent and the risk-free rate is currently 4.50 percent.
Portfolio
Actual average return
Standard deviation
beta
Manager y
10.20%
12%
1.20
Manager z
8.80%
9.90%
0.80
a) For both Manager Y and Manager Z, calculate the expected return using the CAPM. Express your answers to the nearest basis point (i.e., xx.xx%).
b) Calculate each fund manager%u2019s average %u201Calpha%u201D (i.e., actual return minus expected return) over the five-year holding period. Show graphically where these alpha statistics would plot on the security market line (SML).
c) Explain whether you can conclude from the information in Part b if: (1) either manager outperformed the other on a risk-adjusted basis, and (2) either manager outperformed market expectations in general.
Portfolio
Actual average return
Standard deviation
beta
Manager y
10.20%
12%
1.20
Manager z
8.80%
9.90%
0.80
Explanation / Answer
a) For both Manager Y and Manager Z, calculate the expected return using the CAPM. Express your answers to the nearest basis point (i.e., xx.xx%).
Expected Return using CAPM :
For Manager Y = 4.50+ 5*1.20 = 10.50
For Manager Z = 4.50+ 5*0.8 = 8.50
b) Calculate each fund manager%u2019s average %u201Calpha%u201D (i.e., actual return minus expected return) over the five-year holding period. Show graphically where these alpha statistics would plot on the security market line (SML).
Alpha of each fund manager:
For Manager Y = 10.20- 10.50 = -0.30%
For Manager Z = 8.80 - 8.50 = 0.30%
c) Explain whether you can conclude from the information in Part b if:
(1) either manager outperformed the other on a risk-adjusted basis,
No, Niether of them
and (2) either manager outperformed market expectations in general.
only Manager Z has outperformed market expectation in general
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