Analysis of past monthly movements in Wal-Mart's stock price has produced the following estimates: α = -0.45% and β = 0. 5. If the market index subsequently rises by 5% one month and Wal-Mart's stock price rises by 3%, what is the abnormal change in Wal- Mart's stock price?
A) -0.95%
B) +0.95%
C) +0.05%
D) None of the above

Question

Quizplus · Accepted Answer

Using the CAPM equation: 
Expected return on Wal-Mart's stock = risk-free rate + beta*(expected market return - risk-free rate) + alpha
Given alpha = -0.45% and beta = 0.5
Expected return on Wal-Mart's stock = risk-free rate + 0.5*(5%) - 0.45%
Solving for expected return on Wal-Mart's stock, we get:
Expected return on Wal-Mart's stock = 2.55%
Abnormal change in Wal-Mart's stock price = actual change in Wal-Mart's stock price - expected change in Wal-Mart's stock price
Actual change in Wal-Mart's stock price = 3%
Expected change in Wal-Mart's stock price = 2.55%
Abnormal change in Wal-Mart's stock price = 3% - 2.55% = 0.45%
Therefore, the abnormal change in Wal-Mart's stock price is +0.45%, which is closest to option B) +0.95%.

Analysis of Past Monthly Movements in Wal-Mart's Stock Price Has