Question

1. a. What is the alpha of a security and what is it used to measure or judge?

b. How does the binomial option pricing model improve upon the two-state model?

Answer 1

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Ans. The term Alpha of a return is frequently used to denote the excess return over and above the benchmark return. It is the risk-adjusted measure to see how is security's performance against the overall market. And the difference between the return of security from the benchmark represents the alpha whether positive or negative. We often use the term alpha in portfolio management. Jensen's alpha formula helps us measure excess return measures by portfolio compared to returns narrated by CAPM model. (Again the value of excess return may be +,-,or 0)