Question

A- if a stock has Alpha=.004, and Beta =1.2 find the expected percent return if the market increases by 2%.

If the actual return is 2%, 3%, or 4%, calculate the abnormal returnIf the actual return is 2%, 3%, or 4%, calculate the abnormal return.

Answer 1

Beta tells us how many times the stock shall move upward or downward with the increase/decrease in the market index.

Alpha tells us that stock has actually moved some more or less (in case of positive & negative alpha respectively) than our expected return as per CAPM.

Here 2% increase in market shall lead to 2.404%approx rise in the stock (i.e. 2*1.2+.004)

Actual Return	Expected Return	Actual Return	Abnormal return(expec.-actual)
2	2.404	2	0.404
3	2.404	3	-0.596
4	2.404	4	-1.596

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