FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)
A fund holds a low-beta portfolio with beta 0.6 and realized excess return of 7.0%. The market excess return was 8.0%. What is its CAPM alpha, and what is the beta-1 leveraged version's alpha if the portfolio is levered to beta 1.0 at the risk-free rate (ignoring financing frictions)?
CAPM alpha is 7.0% minus 0.6 times 8.0%, which equals 2.2%. Levering to beta 1 multiplies the position by 1/0.6, so alpha scales to about 3.67%, which is the logic behind betting against beta strategies.
- AAlpha 2.2%; levered alpha 3.67%Correct
- BAlpha 2.2%; levered alpha 2.2%
- CAlpha 4.8%; levered alpha 8.0%
- DAlpha 1.0%; levered alpha 1.67%
Explanation
Alpha = 7.0 − 0.6×8.0 = 2.2%. Levering by 1/0.6 = 1.667 scales excess return and beta, so alpha scales too: 2.2×1.667 = 3.67%. Keeping alpha at 2.2% ignores the scaling of leverage.
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