Answer: the investor holds a well-diversified portfolio with negligible diversifiable risk.

## Explanation Jensen's alpha is most appropriate when measuring portfolio performance for well-diversified portfolios where diversifiable risk (idiosyncratic risk) is negligible. Here's why: ### Key Concepts: 1. **Jensen's Alpha** measures the excess return of a portfolio relative to its expected return based on the Capital Asset Pricing Model (CAPM). 2. **CAPM Assumptions**: The model assumes investors hold well-diversified portfolios, eliminating idiosyncratic (unsystematic) risk. 3. **Diversifiable vs. Non-diversifiable Risk**: - **Idiosyncratic risk**: Risk specific to individual assets that can be eliminated through diversification - **Systematic risk**: Market risk that cannot be diversified away ### Why Option C is Correct: - When an investor holds a well-diversified portfolio, the only relevant risk is systematic risk (beta). - Jensen's alpha uses CAPM, which assumes perfect diversification, making it appropriate for evaluating such portfolios. - The alpha represents the manager's skill in generating returns beyond what would be expected given the portfolio's systematic risk. ### Why Other Options are Incorrect: - **Option A**: Jensen's alpha is NOT appropriate when idiosyncratic risk is relevant because CAPM assumes this risk has been eliminated through diversification. - **Option B**: Jensen's alpha is not specifically designed for comparing different asset classes like real estate vs. equity; it's better suited for comparing portfolios within the same asset class framework. ### Practical Application: Jensen's alpha is widely used to evaluate mutual fund and portfolio manager performance, particularly for equity portfolios that should be well-diversified according to modern portfolio theory principles.

Author: LeetQuiz .