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CMA Final · Strategic Financial Management · Portfolio Performance Evaluation and Portfolio Revision

A portfolio returned 17% with beta 1.2 and total standard deviation 20%. The risk-free rate is 6%, the market return is 13% and the market standard deviation is 15%. Under Fama's decomposition, what is the net selectivity of the portfolio (actual return less the return required for its total risk)?

Net selectivity compares actual return with the return justified by total risk using the capital market line. That return is 6% + (7/15) × 20% = 15.33%. Actual return is 17%, so net selectivity is 1.67%, lower than Jensen's alpha of 2.60% because of the diversification component.

  1. A1.67%Correct
  2. B2.60%
  3. C0.93%
  4. D4.00%

Explanation

Return required for total risk = 6 + (7/15) × 20 = 15.33%. Net selectivity = 17 − 15.33 = 1.67%. Jensen's alpha is 17 − (6 + 1.2×7 = 14.4) = 2.60%, which uses beta only. The difference 15.33 − 14.4 = 0.93% is the diversification element. 4.00% compares with the market return.

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