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Two portfolio managers, Mr. P and Mr. Q, claim that they are both good at picking under-priced stocks. Over the years, the average 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 identical period, the average return on the market portfolio has been 12%, with standard deviation 15%. You approximation that the covariance between Mr. P's portfolio and the market has been σPM=0.018, while the covariance between Mr. Q's portfolio and the market has been σQM=0.0315. At last, you estimate that the average return on money market funds has been 2% (risk-free rate).
(a) Calculate the expected returns on Mr. P's and Mr. Q's portfolios that would be consistent with CAPM.
(b) Given CAPM as the benchmark, is either of the two managers over-performing the market? What if you use the Sharpe Ratio as benchmark? Explain the answer carefully.
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