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Alpha
Alpha is used in finance to measure the performance of a stock, portfolio, or other investment by comparing its returns to the market.
- If alpha is positive, the investment outperformed the market, the asset is underpriced.
- If alpha is negative, the investment underperformed the market.
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Example: Alpha
An investor invested in a stock with a beta of 1.2 last year and earned a return of 8.5%. The market return this year was 6% and the risk-free rate is 4%. How did the stock perform?
Mark Yourself Question
- Grab a piece of paper and try this problem yourself.
- When you're done, check the "I have answered this question" box below.
- View the solution and report whether you got it right or wrong.
Practice: Alpha
Your portfolio manager claims to always beat the market and in the last year the money you've invested with her has earned 20%. The beta of the portfolio the manager has put together is 1.7. Last year the market return equally 14% and the risk-free rate was 3%. Did your portfolio manager actually beat the market?