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NISM Certifications · NISM-Series-V-A: Mutual Fund Distributors · Risk, Return and Performance of Funds

A fund has a beta of 1.2, the risk-free rate is 7%, and the expected market return is 12%. Using the CAPM, what return is required from the fund, and if the fund actually delivered 12.5%, what is its Jensen's alpha?

The CAPM required return is 13%, from 7% plus 1.2 times the 5% market premium. The fund delivered 12.5%, so Jensen's alpha is negative 0.5%, meaning it underperformed its risk-adjusted benchmark return.

  1. ARequired 13%; alpha -0.5%Correct
  2. BRequired 13%; alpha +0.5%
  3. CRequired 14.4%; alpha -1.9%
  4. DRequired 12%; alpha +0.5%

Explanation

Required return = 7 + 1.2 x (12 - 7) = 7 + 6 = 13%. Alpha = actual - required = 12.5 - 13 = -0.5%. The +0.5% option reverses the sign, and 14.4% wrongly multiplies beta by the market return minus nothing (1.2 x 12).

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