A security has an expected rate of return of 0.12 and a beta of 1.1. The market expected rate of return is 0.09, and the risk-free rate is 0.04. The alpha of the stock is
A) 9.7%.
B) 7.7%.
C) 5.3%.
D) 2.5%.

Question

Quizplus · Accepted Answer

Alpha is calculated as the difference between the expected return of the security and the expected return predicted by the Capital Asset Pricing Model (CAPM). The CAPM expected return is calculated as: Risk-free rate + Beta * (Market return - Risk-free rate) = 0.04 + 1.1 * (0.09 - 0.04) = 0.095. The alpha is then: 0.12 - 0.095 = 0.025 or 2.5%.

A Security Has an Expected Rate of Return of 0