Question

You are evaluating a fund that had an annual average return of 7.2%. During that time, the average risk-free rate was 1.5% and the average market return was 8%. If the fund's beta is 0.8, what was its alpha? Answer in percent, rounded to one decimal place (e.g. 4.32% = 4.3).

Answer 1

Answer:

Risk free rate(Rf) = 1.5%

Market return(Rm) = 8%

Beta(β) = 0.8

ER(P) = Rf  + β(Rm – Rf)

ER(P) = 1.5 + 0.8(8-1.5)

ER(P) = 1.5 + 0.8(6.5)

ER(P) = 1.5 + 5.2

ER(P) = 6.7%

Alpha = Annual average return - ER(P)

         = 7.2% - 6.7%

         = 0.5%

Explanation:

In this case, we will calculate the expected return on the stock based on CAPM. Thereafter, we will calculate alpha by deducting the expected return from annual average return.