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 beta was 1.2, and the market return was 9.0%. Using the CAPM, what was the portfolio's Jensen's alpha?
Jensen's alpha is 0.8%. CAPM expected return is 3% plus 1.2 times the 6% market premium, which equals 10.2%. The realized return of 11.0% exceeds this by 0.8%, so the manager added positive risk-adjusted excess return.
- A0.8%Correct
- B2.0%
- C1.0%
- D-0.8%
Explanation
Expected return under CAPM = 3.0% + 1.2 x (9.0% - 3.0%) = 10.2%. Alpha = 11.0% - 10.2% = 0.8%. Using 9.0% - 3.0% as the market risk premium on its own, or ignoring beta, gives wrong results such as 2.0%.
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