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CMA Final · Strategic Financial Management · Efficient Market Hypothesis

A fund manager's record over 10 years shows an average annual return of 14% with a standard deviation of 18%. The risk-free rate is 6%, and the market return was 12% with the fund's beta at 1.1. Under the CAPM, which statement best fits a test of whether the manager beat an efficient market after adjusting for risk?

Alpha is +1.4%. CAPM required return is 6% plus 1.1 times the 6% market premium, which is 12.6%. The fund earned 14%, so the excess is 1.4%. Comparing with the 12% market return ignores beta and overstates alpha. Persistent positive alpha would challenge efficiency.

  1. AAlpha is +1.4%, so the manager earned a positive risk-adjusted excess returnCorrect
  2. BAlpha is +2.0%, since fund return exceeds market return
  3. CAlpha is -0.6%, since beta exceeds 1
  4. DAlpha is zero because the Sharpe ratio is positive

Explanation

Required return = 6 + 1.1(12-6) = 6 + 6.6 = 12.6%. Alpha = 14 - 12.6 = +1.4%. Comparing with the market return of 12% ignores beta and gives 2.0%. Alpha is not defined by Sharpe ratio being positive.

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