FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)
A portfolio returned 12% over a year. The risk-free rate was 3%, the market return was 9%, and the portfolio's beta was 1.2. Using the CAPM, what was the portfolio's Jensen's alpha?
Jensen's alpha is 1.8%. The CAPM required return is 3% plus 1.2 times the 6% market premium, which equals 10.2%. The portfolio earned 12%, so the return beyond what its market exposure justifies is 1.8 percentage points.
- A1.8%Correct
- B2.4%
- C3.0%
- D0.0%
Explanation
CAPM expected return = 3% + 1.2 x (9% - 3%) = 10.2%. Alpha = 12% - 10.2% = 1.8%. Using 12% - 9% = 3% ignores the beta adjustment, and 2.4% comes from applying beta to the excess return incorrectly.
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