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Assume that the economy has three types of people.20% are fad followers,75% are passive investors,and 5% are informed traders.The portfolio consisting of all informed traders has a beta of 1.4 and an expected return of 16%.The market has an expected return of 10% and the risk-free rate is 4%.
-The alpha for the fad follower's portfolio is closest to:

Question

Quizplus · Accepted Answer

Since fad followers are expected to be irrational traders, their portfolio is likely to have a negative alpha. The CAPM equation is given by:

Expected Return = Risk-free Rate + Beta * (Market Return - Risk-free Rate) + Alpha

Since the portfolio consisting of all informed traders has a beta of 1.4 and an expected return of 16%, we can solve for alpha:

16% = 4% + 1.4 * (10% - 4%) + Alpha
Alpha = -0.9%

Therefore, the alpha for the fad follower's portfolio is closest to -0.9%, which is closest to answer choice A.

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