Question

Security A has an expected rate of return of 12% and a beta of 1.1. The market expected rate of return is 8%, and the risk-free rate is 5%. The alpha of the stock is _________.

Answer 1

Answer:

The alpha of the stock is 3.7%.

Explanation:

Alpha is the abnormal or additional return expected or received on a stock in excess of the required rate of return for such a stock as calculated by the Security market line or Capital asset pricing model equation.

We first need to calculate the required rate of return for such a stock and then deduct that rate from the expected rate of return to reach at alpha or the abnormal return.

• Required rate of return (r) = 0.05 + 1.1 * (0.08 - 0.05) = 0.083 or 8.3%

The abnormal return or alpha for such a stock is,

• Alpha = 12% - 8.3% = 3.7%