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CMA Final · Strategic Financial Management · Efficient Market Hypothesis

A fund manager, Ravi, runs an actively managed equity fund with 3 years of data. Annual fund return was 15% while the CAPM-required return, using beta 1.1, risk-free 6% and market return 12%, applies. If markets are semi-strong efficient, what is the fund's alpha and the best expectation for its future alpha before costs?

Alpha is 2.4% and future alpha is expected to be zero. CAPM return is 6 + 1.1 x 6 = 12.6%, so 15% gives 2.4% excess. In a semi-strong efficient market such past outperformance is treated as luck and not expected to persist.

  1. AAlpha 2.4%; expected to persist at 2.4%
  2. BAlpha 3.0%; expected to persist at 3.0%
  3. CAlpha 2.4%; expected to be zero going forward, past alpha being luckCorrect
  4. DAlpha 9.0%; expected to be zero going forward

Explanation

Required return = 6 + 1.1 x (12 - 6) = 12.6%. Alpha = 15 - 12.6 = 2.4%. Under efficiency, past alpha is attributed to chance and expected future alpha is zero. Distractor 3.0% ignores beta (15 - 12).

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