FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)
A manager's portfolio has beta 1.5 and the market has an expected excess return of 6%. The portfolio's expected excess return is 11%. The manager wants to remove market exposure using index futures while keeping the stock selection. After hedging to a beta of zero, what is the expected excess return of the hedged portfolio, assuming a beta hedge with no cost and a CAPM-consistent hedge?
The hedged portfolio's expected excess return is 2%. The portfolio's beta contributes 1.5 times 6%, or 9%, which the futures hedge removes. What remains is the 11% total minus 9%, which is the pure alpha of 2%.
- A2.0%Correct
- B11.0%
- C9.0%
- D5.0%
Explanation
The beta component is 1.5 x 6% = 9%. Hedging to beta zero removes it, leaving 11% - 9% = 2%, the alpha. Leaving 11% ignores the hedge, and 5% subtracts only the market premium without scaling by beta.
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