Problem 3

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:

Portfolio	Actual average Return	Standard Deviation	Beta
Manager Y	10.20%	12.00%	1.20
Manager Z	8.80%	9.90%	0.80

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.

For both Manager Y and Z, calculate the expected return using the CAPM.

Calculate each fund managers average alpha (actual minus expected return ) over the period. Show graphically where the alpha statistics would plot on the security market line (SML).

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 the market.