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FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

A hedge fund returned 14% in a year when the risk-free rate was 3%. A factor model estimates alpha from a regression on a market factor with beta 0.5, and the market return was 12%. Assuming a single-factor model with excess returns, what is the fund's annual alpha?

Alpha is 6.5%. The fund's excess return is 11% (14% less 3%), and the beta-explained portion is 0.5 times the 9% market excess return, or 4.5%. The remaining 6.5% is unexplained by the market factor and is alpha.

  1. A6.5%Correct
  2. B2.0%
  3. C7.0%
  4. D11.0%

Explanation

Fund excess return is 14% - 3% = 11%. Market excess return is 12% - 3% = 9%, and beta times this is 4.5%. Alpha = 11% - 4.5% = 6.5%. Option D ignores beta, and option B subtracts the wrong figure.

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