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CMA Final · Strategic Financial Management · Efficient Market Hypothesis

A mutual fund manager claims skill. Over a period the fund earned 17%, with Rf 7%, market return 14% and fund beta 1.3. A market-efficiency sceptic computes the CAPM-required return and concludes about the fund's alpha as follows. Which conclusion is correct?

Alpha is +0.9%, since the CAPM required return is 16.1% (7% plus 1.3 times 7%) against an actual 17%. A single period's small positive alpha can arise from luck, so it does not by itself refute market efficiency.

  1. AAlpha is +0.9%, positive, but a single period does not by itself refute efficiencyCorrect
  2. BAlpha is -0.9%, so the fund underperformed
  3. CAlpha is +3.0%, clearly refuting efficiency
  4. DAlpha is zero, so the fund matched the market

Explanation

Required return = 7 + 1.3×(14-7) = 7 + 9.1 = 16.1%. Alpha = 17 - 16.1 = +0.9%. One period's small positive alpha can arise by chance, so it does not disprove efficiency. The 3.0% figure is 17 - 14, ignoring beta.

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