NISM Certifications · NISM-Series-XV: Research Analyst · Fundamentals of Risk and Return
The risk-free rate is 7%, the market return is 12% and a stock has beta 1.4. The stock is expected to return 13%. Using CAPM, what is its alpha?
Alpha is -1%. CAPM gives a required return of 7% + 1.4 × 5% = 14%. The stock is expected to deliver only 13%, so it falls 1 percentage point short of its required return and is overvalued relative to its risk.
- A-1%Correct
- B+1%
- C+6%
- D0%
Explanation
Required return = 7 + 1.4×(12-7) = 14%. Alpha = expected 13% minus required 14% = -1%. Using +1% reverses the sign, and 6% is just the excess over the risk-free rate.
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