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FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)

A fund earns a 7% return with a beta of 0.5 to the market. The risk-free rate is 2% and the market return is 8%. A manager claims alpha of 5% because the fund beat cash by 5%. What is the fund's actual CAPM alpha?

The CAPM alpha is 2%. The fund's required return is 2% plus 0.5 times the 6% market premium, or 5%. Subtracting this from the realized 7% leaves 2%; the manager's 5% claim wrongly counts beta compensation as skill.

  1. A2.0%Correct
  2. B5.0%
  3. C0.0%
  4. D4.0%

Explanation

Expected return = 2% + 0.5 x 6% = 5%. Alpha = 7% - 5% = 2%. The manager's claim of 5% is just the excess return over cash, which includes 3% compensation for market beta exposure.

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