Part 1 of 4:

Based on the stock's beta and market expected return, stock A's alpha is:
[ Select ]
1%
3%
-1%
-3%

Based on the stock's beta and market expected return, stock B's alpha is:
[ Select ]
2.8%
-6%
-2.8%
6%

Question

Part 1 of 4:

Based on the stock's beta and market expected return, stock A's alpha is: 
[ Select ]
1%
3%
-1%
-3%

Based on the stock's beta and market expected return, stock B's alpha is: 
[ Select ]
2.8%
-6%
-2.8%
6%

BlackTom AI · Accepted Answer

We start by restating what alpha represents in CAPM terms: alpha is the difference between the actual return of the stock and its CAPM-implied expected return, i.e., alpha = R_i − [R_f + β_i × (R_m − R_f)]. This means alpha can be positive, negative, or zero depending on how well the stock performs relative to its risk-adjusted expectation. Since the prompt provides only the possible alpha values for two stocks and no numeric values for beta, market return, or risk-free rate, we cannot compute the alphas from first principles here; instead, we evaluate each option in terms of what alpha represents and what its sign implies.

Analyzing Stock A options: 1%, 3%, -1%, -3%
- 1%: If Stock A’s alpha were 1%, this would mean the stock outperformed its CAPM expectation by one percentage point. In plain terms, the stock delivered more return than what its beta and the market implied. This is a plausible alpha value if there was a positive surprise beyond systematic risk.
- 3%: A 3% alpha would indicate a relatively large positive deviation from CAPM expectations. While possible, such a large positive alpha would require substantial factors beyond beta to be at play, and you would expect corresponding disclosures or notes about unusual performance drivers.
- -1%: An alpha of −1% means the stock underperformed its CAPM expectation by one percentage point. This negative residual is common when a stock’s actual return fails to meet the return predicted by its beta in the given market conditions.
- -3%: A −3% alpha would reflect a relatively substantial underperformance relative to CAPM. This is possible but less common than smaller deviations unless there were negative idiosyncratic events or downturns not captured by beta.

Analyzing Stock B options: 2.8%, -6%, -2.8%, 6%
- 2.8%: A positive alpha of 2.8% implies Stock B beat its CAPM-predicted return by 2.8 percentage points. This would suggest favorable idiosyncratic performance beyond systematic risk.
- -6%: A large negative alpha like −6% would indicate a substantial underperformance relative to its CAPM expectation, which would generally require pronounced negative factors or events not explained by beta.
- -2.8%: A negative alpha of −2.8% points to underperformance by 2.8 percentage points relative to CAPM. This is a reasonable range for an alpha when stock-specific factors detract from expected returns.
- 6%: A positive 6% alpha would reflect a very large outperformance beyond CAPM, which would be notable and would typically be accompanied by strong supporting explanations for the excess return.

Connecting to the provided selections: the given answers are -1% for Stock A and -2.8% for Stock B. Interpreting these as the alphas, they indicate that Stock A underperformed its CAPM expectation by 1 percentage point, and Stock B underperformed by 2.8 percentage points. This aligns with a scenario where both stocks delivered returns that did not fully meet their risk-adjusted expectations, i.e., their actual performances fell short of what CAPM would predict given their betas and the market environment.

Why the other options are less consistent in typical CAPM reasoning:
- For Stock A, 1% or 3% alphas would require the stock to outperform CAPM by those amounts, which is a different sign from the chosen −1% in the provided answer; these imply positive residuals rather than negative ones.
- For Stock A, -3% suggests a larger underperformance than -1%; while possible, the question’s paired answers indicate a milder underperformance, so the chosen -1% reflects a smaller negative residual.
- For Stock B, 2.8% or 6% would indicate outperformance; again, these would imply positive residuals contrary to the given pair, which shows negative residuals. Conversely, -6% would imply an even larger underperformance than -2.8%, which is not what the provided answer set indicates.
- In practice, any of these alphas could occur depending on actual returns and market conditions, but the pair of negative values suggests a consistent theme of underperformance relative to CAPM for both stocks in the scenario implied by the provided answers.

COMM_V 298 101 102 103 2025W1 Class 16 Practice Quiz

Part 1 of 4: Based on the stock's beta and market expected return, stock A's alpha is: [ Select ] 1% 3% -1% -3% Based on the stock's beta and market expected return, stock B's alpha is: [ Select ] 2.8% -6% -2.8% 6%

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Similar Questions

Part 1 of 4: Based on the stock's beta and market expected return, stock A's alpha is: [ Select ] 3% -3% -1% 1% Based on the stock's beta and market expected return, stock B's alpha is: [ Select ] -6% 2.8% 6% -2.8%

Part 2 of 3: If the Stock X's beta is 0.8, the expected return of the market is 15% and the risk free rate is 5%, what is Stock X's alpha? Round your answer to four decimals. DO NOT use percentage format. E.g. 10.51% should be entered as 0.1051

Suppose Boeing stock has a market beta of 1.75 and an expected return of 8%. Suppose the stock market has an expected return of 6%, and the risk-free rate is 2%. What is the CAPM alpha of Boeing stock? Assume the stock market is representative of the entire market portfolio.

Stock X has an expected excess return of 12% and its beta is 1.25. The Market portfolio expected return is 8% and the risk-free rate is 2%. What is the alpha of Stock X? Enter your answer to 4 decimal places eg if your answer is 1.44% enter as 0.0144 If your answer is 1% enter as 0.0100

Part 1 of 4: Based on the stock's beta and market expected return, stock A's alpha is: 3% Based on the stock's beta and market expected return, stock B's alpha is: -2.8%

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