Portfolio Risk and Return: Part II: practice question
The Orbank Diversified Fund earned a return of 10.2% last year. The fund's beta is 1.10, the risk-free rate was 3.0%, and the market portfolio returned 8.0%. The fund's Jensen's alpha is closest to:
- +1.70%
- +2.20%
- +4.70%
Show answer and explanation
Correct answer: A
Working: Required = 3.0% + 1.10 × (8.0% − 3.0%) = 8.5%; alpha = 10.2% − 8.5% = +1.70%
Explanation: A is correct: alpha is the actual return minus the beta-adjusted CAPM required return, 10.2% − 8.5% = +1.70%, so the fund beat its risk-adjusted benchmark. B is wrong because 2.20% compares the fund's return with the raw market return (10.2 − 8.0), ignoring both the risk-free rate and the fund's beta. C is wrong because 4.70% omits the risk-free rate when building the required return (10.2 − 1.10 × 5.0).
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