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Alpha and Beta

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Submitted By hilder
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Elijah Ongeri Matini BBM2735/14
BBM 413 Assignment a) Alpha
A measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha.
Alpha is one of five technical risk ratios; A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha would indicate an underperformance of 1%.
The Jensen index, or alpha, bears some relation to the capital asset pricing model, or CAPM. The CAPM equation is used to identify the required return of an investment; it is often used to evaluate realized performance for a diversified portfolio. Because it's assumed that the portfolio being evaluated is a diversified portfolio (meaning that the unsystematic risk has been eliminated), and because a diversified portfolio's main source of risk is market risk (or systematic risk), beta is an appropriate measure of that risk. Alpha is used to determine by how much the realized return of the portfolio varies from the required return, as determined by CAPM. The formula for alpha is expressed as follows:
|α = Rp – [Rf + (Rm – Rf) β] |

Where:
Rp = Realized return of portfolio
Rm = Market return
Rf = risk-free rate
The Jensen index measures risk premiums in terms of beta (β); therefore, it is assumed that the portfolio being evaluated is well diversified. The Jensen index requires using a different risk-free rate for each time interval measured during the specified period. For instance, if you are measuring the fund managers over a five-year period using annual intervals, you must examine the fund's annual returns minus the risk-free assets' returns (i.e. U.S. Treasury bill or

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