Question

Stock ABC has an expected return of 6.47%, based upon a beta of 1.15. The risk-free rate is 2.58%. If the actual return on Stock ABC turns out to be 8.55% and the actual return on the market turns out to be 7.58%, what portion of the unexpected return can be attributed to unsystematic risk?

Answer 1

Alpha is the measure of unsystematic risk which is difference between required return and expected return.

As given, actual return on stock A=8.55% while expected return=6.47%, So alpha for Stock A=8.55-6.47=2.08

And for market, actual return is 7.58%.

Expected return on market as per Capital Asset Pricing Model:

6.47=2.58+1.15(market return-2.58)

1.15(market return-2.58)=3.89

market return-2.58=3.38

market retturn=5.96%

alpha for market=7.46-5.96=1.5

So portion of unexpected return that can be allocated to unsystematic risk=2.08-1.5=0.58