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. If the T-bill rate were 6% and the market return during the period were 14%, which adviser would be the superior stock selector

As the excess return of the second adviser (2%) was more than that of the first adviser (1%), the Second adviser was the superior stock selector.

Explanation:

To determine which adviser would be the superior stock selector, we will calculate the required rate of return of each adviser and the return actually averaged. The adviser with the greater abnormal return which is return in excess of required rate will be the superior stock selector.

Using the CAPM, we can calculate the required rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

r or First adviser = 0.06 + 1.5 * (0.14 - 0.06)

r or First adviser = 0.18 or 18%

Abnormal or excess return of First adviser = 19% - 18% = 1%

r or Second adviser = 0.06 + 1 * (0.14 - 0.06)

r or First adviser = 0.14 or 14%

Abnormal or excess return of Second adviser = 16% - 14% = 2%

The Second adviser was the superior stock selector.

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