Practice Quiz

FRM Financial Risk Manager Practice Test

Category - The Capital Asset Pricing Model

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According to the CAPM, portfolios may randomly outperform or underperform the market from one year to the next. However, when portfolios consistently outperform the market over the years, which of the following is NOT true about alpha?
  1. Alpha is the difference in the expected returns of the portfolio that is performing well over the years and that of the market portfolio.
  2. Alpha shows a persistent positive contribution to a portfolio's expected return due to the manager's skill.
  3. Alpha cannot be negative.
  4. If alpha is positive, it means that investment portfolios outperform the market portfolio. If alpha is negative, it means that investment portfolios underperform the market portfolio.
Explanation
Alpha can be negative. A, B and D are all true.

Key Takeaway: Empirical evidence shows that investment managers rarely have a positive alpha. Michael Jensen (1968) was the one who defined alpha and conducted research to calculate some mutual funds’ alphas and saw if they were positive. The result showed that the vast majority of the funds had negative estimated alpha.
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