Question

8) Suppose you were evaluating the performance of three different funds. Your analysis produces the following results:

Fund	Alpha	Beta
Hedge fund following a market neutral strategy	0.1	1.6
Mutual fund investing actively in stocks and bonds	-0.1	0.4
Index Fund tracking the S&P 500 Index	0.1	1.6

Describe the performance of each fund (i.e. good, bad, average etc.) and explain your answer in each case.

Answer 1

Alpha:-

Meaning of Alpha:-Alpha measures performance of stock. If Alpha is positive it means that stock has performed better than market. If Alpha is negative it shows than stock has under performed than the market. If it is Zero it means it has performed as the market.

Formula of Alpha= Return of Stock or portfolio- CAPM Return

Where CAPM Return is = Risk Free Return + Beta (Market Return – Risk Free Return)

Beta:-

Meaning of Beta: - Beta shows the degree of effect of the market on the stock. In other words this shows relation with the market.

Formula of Beta: -Change in security/ Stock Return/Change in Market Return

Evaluation of Different Funds

Hedge fund Following a market Neutral Strategy: -

Alpha= 0.1:- Its Alpha is positive it shows that Stock has performed better than the market.

Beta=1.6: -Beta is at higher side. It shows that this stock is very sensitive with the market hence Risky.

Conclusion: - Good, It is too risk bearing but providing positive Results hence it is good investment for those who prefer return over security.

Mutual Fund investing Actively in stocks and bonds

Alpha= - 0.1:- Its Alpha is negative it shows that Stock has performed below than the market.

Beta= 0.4: -Beta is at Lower side. It shows that this stock is less sensitive with the market hence secured.

Conclusion:- Average , As it is too risk bearing but providing positive Results. It is less effective investment for those who prefer return over security.

Index fund tracking the S&P 500 Index: -

Alpha= 0.1:- Its Alpha is positive it shows that Stock has performed better than the market.

Beta=1.6: -Beta is at higher side. It shows that this stock is very sensitive with the market hence Risky.

Conclusion: - Good, It is too risk bearing but providing positive Results hence it is good investment for those who prefer return over security.