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Alpha

Alpha refers to the return achieved relative to the return expected given the investment’s beta value.

The return achieved on the portfolio – actual portfolio return

Minus the CAPM equation 

Rate of return on a risk-free asset 

Rate of return of the market portfolio 

Volatility of the investment with regard to the market 

Example:

An investment portfolio has an annualised return of 12% and a beta value of 1.4. Return on Treasury Bills is 3% and the average market return is 10% over the same period. Calculate Alpha.

  • First we know the values for the rates of return and beta:
  • These figures are then placed into the formula.
  • The Alpha is -0.8%. This indicates that the investment has performed worse than would be predicted by its beta value. 

Questions - Use Your Note Taker To Jot Down Ideas / Calculations

1. An investment portfolio has an annualised return of 11% and a beta value of 1.2. Return on Treasury
Bills is 2.5% and the average market return is 9% over the same period. Calculate Alpha.

a) 0.7

b) 1.4

c) 0.5

d) -0.8

A)

Use the Alpha formula to calculate the answer.

Put figures from the question into the formula as follows.
Actual return = 11%
Rf = 2.5%
Beta = 1.2
Rm = 9%
11% – [2.5% + 1.2 (9% – 2.5%)]
This gives us an alpha value of 0.7. This indicates that the investment has performed better than
would be predicated by its beta.

  • Further Study Text: Pages 403 - 405