Question

You are assigned to evaluate the performance of the CDF stock. You collect the past data on the risk-free assets, the stock, and the market index. You use the excess returns of the stock and the market index to run the regression. The regression yields an intercept, equal to -.02 and a beta equal to 1.2. The standard error of the alpha is .09. The average returns for the risk-free asset, the stock, and the market index are .05, .15, and .10 respectively. The standard deviations (based on excess returns) for the stock and the market index are .20 and .30 respectively. What should your conclusion be on the stock’s performance based on Jensen measure?

Select one:

a. CDF stock underperformed the market portfolio.

b. CDF stock outperformed the market portfolio.

c. CDF stock did not either outperform or under-perform the market portfolio. That is , the stock had normal performance.

Answer 1

Mathematically, Jensen's Measure ( Also called Alpha) is the rate of return that exceeds what was expected or predicted by capital asset pricing model.

Alpha = Rp - Rf + Beta X (Rm-Rf)

Where

Rp = The security of portfolio's return

Rf = The risk free rate of return

Rm = The market return

Beta= the securities price volatality relative to overall market

substuting all values in the above formula, we get

Alpha = 0.15 - 0.05 + 1.2*(0.10-0.05) = 0.04

From the above result, we can say that the CDF stock outperformed the market portfolio.