Question

4. Consider the following information about the market portfolio, the risk-free asset and funds A and B. Return Standard Deviation Beta 5% 0% Risk-free asset 0 Market portfolio Fund A 15% 20% 1 40% 12% 0 30% Fund B 18% 1.5 Analyze the performance of fund A relative to fund B in the context of the CAPM.

Answer 1

CAPM says required return=risk free rate+beta*(market return-risk free rate)

Required return of Fund A=5%+0*(15%-5%)=5%

Required return of Fund B=5%+1.5*(15%-5%)=20%

Alpha=Expected Return-Required Return

Alpha of Fund A=12%-5%=7%

Alpha of Fund B=18%-20%=-2%

Fund A performed better than Fund B