Question

If the risk/return performance of a stock lies above the Security Market Line, the stock is said to have a:

	a.	Positive expected return
	b.	Positive covariance
	c.	Positive correlation coefficient
	d.	Positive alpha

Answer 1

Answer is option (d). Positive alpha

Explanation;

If the risk/return performance of a stock lies above the Security Market Line, the stock is said to have a positive alpha. As we know that the difference between expected return and required return is known as alpha. If the stock is undervalued & it lies above the security market line (SML) then alpha will be positive. In opposite case when the stock is overvalued & it falls below the security market line (SML) then alpha will be negative.

So on the basis of above explanation, it is clear that option (d) is correct answer.