Question

You find that the expected return for the market is 14.7% and the risk free rate is 1.3%. You are interested in Morgan Stanley (MS). You know the beta of MS is 0.81. However, you think the Capital Asset Pricing Model (CAPM) is not complete, and you do your own personal analysis. You think that the expected return of MS should be 13.7%. Base on this, what would be the alpha of MS?

{Give your answer as a percentage with 2 decimals, e.g., if the answer is 0.0345224 (or 3.45224%) , enter 3.45 as your answer.}

Answer 1

• Expected Return is the actual return earned by the stock.
• Required rate of return is the return an investor expects to earn from a stock.

As per Capital Asset Pricing Model (CAPM)

Re = Rf + (Rm-Rf) β

Where Re = Required rate of return

Rf = Risk free rate of return

Rm – Market Return or Expected Return on Market

β – Beta

Rf = 1.3 %

Rm = 14.7%

Beta = 0.81

Re = Rf + (Rm-Rf) β

Re = 1.3 + (14.7 - 1.3)*0.81

= 1.3 + 13.4 * 0.81

= 1.3 + 10.854

= 12.154

Rounding to two decimal places

= 12.15 %

Calculation of Alpha

Alpha = Expected Return - Required rate of return

=13.7 % - 12.15%

= 1.55