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Question

According to the capital asset pricing model, a security with a _________.

A Negative alpha is considered a good buy Correct Answer Incorrect Answer
B Positive alpha is considered overpriced Correct Answer Incorrect Answer
C Positive alpha is considered underpriced Correct Answer Incorrect Answer
D Zero alpha is considered a good buy Correct Answer Incorrect Answer
E Negative alpha is considered underpriced Correct Answer Incorrect Answer

Solution

The excess return of an investment relative to the return of a benchmark index is the investment's alpha. As per CAPM model, alpha would be the difference between the actual return earned and the required rate of return. Therefore, when the alpha is positive (ie. Actual return > required return as per CAPM), it means the security is underpriced leading to a higher actual return.

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