Explain Expected returns in portfolio.
Two portfolio managers Mr. P and Mr. Q claim that they are both good at picking under-priced stocks. Over the years the usual return on the portfolio managed by Mr. P has been 14.1%, with standard deviation 18%, while the average return of Mr. Q's portfolio has been 15%, with standard deviation 20%. Over the same period the average return on the market portfolio has been 12% with standard deviation 15%. You approximate that the covariance between Mr. P's portfolio and the market has been σPM=0.018 while the covariance among Mr. Q's portfolio and the market has been σQM=0.0315. Lastly you approximate that the average return on money market funds has been 2% (risk-free rate).
1) Calculate the expected returns on Mr. P's and Mr. Q's portfolios that would be consistent with CAPM.
2) Given the CAPM as the benchmark is either of the two managers over-performing the market? Explain what if you use the Sharpe Ratio as benchmark? Describe your answer carefully.