Question

1. Assume both Portfolio Manager X & Y know with absolute certainty that one period from now, Sector 1 will return 20%, Sector 2 will return -10%, and the SP500 will return 8%. Both PM X & Y use the SP500 as a benchmark, want to maximize return on equity, and pay no taxes. Portfolio X is long onlywith $200M of equity to invest in either Sector 1 or Sector 2. Portfolio Y only has $100M of equity to invest in either sector, but can also short$100M of either sector and reinvest the proceeds. One period from now, which of the following statements is most likely TRUE:

1. PM X will outperform the benchmark by 12% and PM Y will outperform the benchmark by 42%
2. PM X will outperform the benchmark by 12% and PM Y will outperform the benchmark by 32%
3. PM X will outperform the benchmark by 12% and PM Y will outperform the benchmark by 30%
4. PM X will outperform the benchmark by 12% and PM Y will outperform the benchmark by 22%
5. PM X and PM Y will both realize the same capital gain (in $s), but realize different ROEs

Answer 1