Question

A share of Amazon stock is currently trading at $3200. A fundamental analyst believes that the stock should be worth $4100 per share (this is the analyst's intrinsic valuation). According to CAPM, the required rate of return on the stock is 2.00% per month. If the manager purchases the stock and it takes 14 months for the market price to converge to the intrinsic value, then what alpha will be earned on this trade?

Answer 1

Realized return in 14 months = 4,100/3,200 - 1

Realized return in 14 months = 1.28125 - 1

Realized return in 14 months = 0.28125

Realized return in 14 months = 28.125%

Realized return per month = 28.125%/12 = 2.34375%

Alpha earned per month = 2.34375% - 2%

Alpha earned per month = 0.34375%