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NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Portfolio Management Process

A portfolio has a beta of 1.2. The risk-free rate is 7% and the expected market return is 12%. Under the CAPM, what is the portfolio's required return, and if it actually earned 14%, what is its alpha?

The required return is 13% and alpha is +1%. Under the CAPM, required return is the risk-free rate of 7% plus beta of 1.2 times the market premium of 5%, giving 13%. The actual 14% exceeds this by 1 percentage point, so alpha is positive.

  1. ARequired 13%; alpha +1%Correct
  2. BRequired 14.4%; alpha -0.4%
  3. CRequired 12%; alpha +2%
  4. DRequired 13%; alpha -1%

Explanation

Required return = 7 + 1.2 x (12 - 7) = 7 + 6 = 13%. Alpha = actual 14% - required 13% = +1%. Option 14.4% wrongly applies beta to the market return of 12%. Option 12% ignores beta. Option with -1% reverses the sign of alpha.

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