Hi Guys,
am I going crazy or did CFAI get it wrong?
I put B but I’ve been studying a lot lately so might be going crazy
Cheers
Greetings friend! Answer B easily can seem like the choice at first blush if you’re quickly comparing the CAPM with the portfolio’s equity premium return, but don’t forget that Jensen’s Alpha actually is calculated as: Portfolio return - [Risk Free Rate + (Portfolio Beta)(Market Return - Risk Free Rate)].
The trick is to remember to add in the risk free rate to the second part of the equation, that you’re subtracting from the portfolio’s return. This is also true for the CAPM estimated total return on equity: you add the risk free rate to that as well, you don’t just multiply Beta times the market premium. Recall that the full CAPM equation is: Risk Free Rate + (Portfolio Beta)(Market Return - Risk Free Rate)
So in this case, the B answer that jumps clearly into your head based on part of the CAPM is missing the 2.5% risk free rate you also need to subtract again from the 15.5% return, to get the correct answer.
Cheers - good luck - you got this 