CMA Final · Strategic Financial Management · Portfolio Performance Evaluation and Portfolio Revision
A mutual fund's annual returns over three years were 12%, 18% and 15%. Over the same period the market's average return was 12% and the risk-free rate was 6%. The fund's beta is 1.3. Using the arithmetic average return, what is the Jensen alpha of the fund?
Jensen alpha is 1.2%. The fund's average return is 15%, while CAPM requires 6% plus 1.3 times the 6% market premium, which is 13.8%. The fund therefore beat its risk-adjusted required return by 1.2 percentage points.
- A1.2%Correct
- B3.0%
- C-0.6%
- D9.0%
Explanation
Average fund return = (12+18+15)/3 = 15%. CAPM required return = 6% + 1.3 x (12% - 6%) = 13.8%. Alpha = 15% - 13.8% = 1.2%. The -0.6% arises from forgetting the risk-free rate (15 - 1.3x12), and 3.0% ignores beta altogether.
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