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

A portfolio returned 11.0% over a year. The risk-free rate was 3.0%, the portfolio's beta to the market was 1.2, and the market return was 8.0%. Using the CAPM, what is the portfolio's Jensen's alpha?

Jensen's alpha is 2.0%. CAPM expected return is 3% plus 1.2 times the 5% market premium, which equals 9%. The realized return of 11% exceeds this benchmark by 2 percentage points, which is the return not explained by market beta.

  1. A2.0%Correct
  2. B3.0%
  3. C5.0%
  4. D-1.0%

Explanation

Expected return = 3% + 1.2 x (8% - 3%) = 9%. Alpha = 11% - 9% = 2.0%. The 3.0% option ignores beta and uses the market excess return (8% - 5%?) incorrectly; the 5.0% option is the market excess return, and -1.0% reverses the sign of a mismatched calculation.

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