Question

A security has an expected rate of return of 0.15 and a beta of 1.25. The market expected rate of return is 0.10 and the risk-free rate is 0.04. The alpha of the stock is

A. 1.7%.

B. -1.7%.

C. 8.3%.

D. 3.5%.

E. none of the above.

Answer 1

The alpha of the stock, given its expected rate of return of 0.15, beta of 1.25, market expected rate of return of 0.10, and risk-free rate of 0.04, is calculated to be 3.5%, which corresponds to answer choice D.

Step-by-step explanation:

The question asks for the calculation of the alpha of a stock given its expected rate of return, its beta, the market expected rate of return, and the risk-free rate. Alpha is a measure of an investment's performance on a risk-adjusted basis. To calculate alpha, one can use the formula:

Alpha = Expected Rate of Return - (Risk-Free Rate + Beta x (Market Expected Rate of Return - Risk-Free Rate))

Plugging in the given values:

Alpha = 0.15 - (0.04 + 1.25 x (0.10 - 0.04))

Alpha = 0.15 - (0.04 + 1.25 x 0.06)

Alpha = 0.15 - (0.04 + 0.075)

Alpha = 0.15 - 0.115

Alpha = 0.035 or 3.5%

Thus, the correct answer is D. 3.5%.