Financial Risk Manager Part 1
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A risk manager is evaluating a portfolio of equities with an annual volatility of 12.1% per year that is benchmarked to the Straits Times Index. If the risk-free rate is 2.5% per year, based on the regression results given in the chart below, what is the Jensen's alpha of the portfolio?
Regression chart (given):
- Scatter of excess returns with axes labeled: Excess Return on Market (%) (x-axis) and Excess Return on Portfolio (%) (y-axis).
- Regression equation shown on chart: y = 0.004936x + 0.037069 (R^2 = 0.5387)
Options:
Exam-Like
UAnonymous
A
0.4936%
B
0.5387%
C
1.2069%
D
3.7069%
Explanation:
The chart shows a regression of portfolio excess returns (y) on market excess returns (x), where both axes are labeled in percent. The regression equation is y = 0.004936 x + 0.037069. In an excess-return regression (portfolio return minus risk-free regressed on market return minus risk-free), the intercept (alpha) is Jensen's alpha expressed in the same units as the axes. The intercept is 0.037069, which corresponds to 3.7069% (since the axes are percent). Therefore Jensen's alpha = 3.7069% per year, option D.
Note: The given volatility and risk-free rate are not needed because the regression is on excess returns and provides the intercept directly as Jensen's alpha.
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