FRM Part I · FRM Exam Part I · The Arbitrage Pricing Theory and Multifactor Models of Risk and Return
Over a year, a portfolio returned 11.0%. The risk-free rate was 3.0%. Its single-factor model has market beta 0.9, and the market return was 9.0%. Using the model with the market excess return as the factor, what is the portfolio's realized alpha?
Alpha is 2.6%. The portfolio's excess return is 8%, while the beta-explained excess return is 0.9 times the 6% market excess return, or 5.4%. The difference, 2.6%, is the return not explained by market exposure.
- A2.6%Correct
- B8.0%
- C5.4%
- D-0.4%
Explanation
Excess portfolio return = 11 - 3 = 8%. Factor-explained part = 0.9 x (9 - 3) = 5.4%. Alpha = 8 - 5.4 = 2.6%. The 5.4% option is the factor return only, and -0.4% results from subtracting 0.9 x 9 from 8.
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