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

A manager holds a portfolio with beta 0.9 that has an expected return of 8.5%. The risk-free rate is 2% and the expected market return is 8%. Which statement is correct?

Expected alpha is 1.1%. The CAPM required return is 2% plus 0.9 times the 6% market premium, which is 7.4%. The portfolio's expected 8.5% exceeds this by 1.1 percentage points, so it plots above the security market line.

  1. AExpected alpha is 1.1%, since required return under CAPM is 7.4%Correct
  2. BExpected alpha is 0.5%, since required return is 8.0%
  3. CExpected alpha is -1.1%, since required return is 9.6%
  4. DExpected alpha is 0, since beta is below 1

Explanation

Required return = 2% + 0.9 x 6% = 7.4%. Alpha = 8.5% - 7.4% = 1.1%. Comparing to the market return (8%) ignores beta and gives 0.5%. Beta below 1 does not force alpha to zero.

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