Skip to content

FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)

A low-volatility equity strategy has returned 9% with a beta of 0.70 to the market. The risk-free rate is 2% and the market return is 10%. Using CAPM, what is the strategy's alpha, and what does it imply?

Alpha is 1.4%. CAPM expected return is 2% plus 0.70 times the 8% market premium, giving 7.6%. The realized 9% exceeds this by 1.4%, a positive alpha consistent with low-beta assets outperforming the security market line.

  1. A+1.4%, positive alpha consistent with the low-risk anomaly
  2. B+0.6%, positive alpha consistent with the low-risk anomalyCorrect
  3. C-0.6%, the strategy underperformed its CAPM benchmark
  4. D+7.0%, the strategy earned its full excess return as alpha

Explanation

Expected return = 2% + 0.70 x (10% - 2%) = 7.6%. Alpha = 9% - 7.6% = +1.4%. Check: 0.70 x 8 = 5.6; 2+5.6 = 7.6; 9 - 7.6 = 1.4. So the correct figure is +1.4%, which is option A.

Did you get it right without looking?

One question tells you little. A timed set on Alpha (and the Low-Risk Anomaly) shows your real accuracy, how long you take and where you lose marks.

Practise Alpha (and the Low-Risk Anomaly)Free diagnostic mock

More Alpha (and the Low-Risk Anomaly) questions