CMA Final · Strategic Financial Management · Asset Pricing Theories
A share of Sundaram Pharma has beta 0.8. Risk-free rate is 7% and the market risk premium is 5%. The share is expected to return 10.5% according to analysts. What is its alpha (expected return minus CAPM required return)?
Alpha is -0.5%. The CAPM required return is 7% plus 0.8 times 5%, which is 11%. The analysts' expected return of 10.5% falls short of this by 0.5 percentage points, so the share plots below the security market line and is overpriced.
- A-0.5%
- B+0.5%Correct
- C+3.5%
- D-3.5%
Explanation
CAPM required return = 7% + 0.8 x 5% = 11%. Alpha = 10.5% - 11% = -0.5%. Wait: this gives a negative value, so the correct option is -0.5%.
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