Question

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 alpha of 1.53%. The market has an expected return of 10% and the risk-free rate is 4 %.

What is the alpha for the fad followers? Enter your answer as a percentage to two decimal places (i.e. 0.12% rather than 0.0012; the percent sign is not necessary).

Answer 1

Type of investors Passive Fad followers Informed traders 75% 20% 5% Rm RF Alpha (informed trader) 10% 4% 1.53% 1.40 1.53%+4%+1.4*(10%-4%) 13.93% Beta Re (informed traders) Re (informed traders) Return for passive investor is 10.00% Overall return is also 10% Return (Fad followers) (10% - 0.75*10%+.05*13.93%))/.20 Return (Fad followers) 9.02% Assuming same beta of 1.40, alpha = 9.02% - 1.4*(10%-4%) Assuming same beta of 1.40, alpha = 0.62%