7.2.1.3. Implications of the CAPM
For active managers, beta is the most commonly used measure of a stock’s riskiness. The assumed relationship between risk and return is a convenient way to measure a stock’s actual performance against its expected returns. Beta as a measure of systematic risk is also a convenient way to compare the riskiness of similar stocks.
Alpha can also be used to measure the performance of mutual fund managers against the returns earned by similar investments over an identical period. When doing this, a beta is calculated for an entire portfolio, and an expected return is calculated using CAPM for the portfolio. The alpha of the portfolio is the performance of the fund above its expected return. Calculating the alpha of a portfolio is one of the most common ways to determine the contribution a mutual fund manager makes to the returns of a fund above what the market itself would have contributed.
Example 1: At the beginning of the year, your customer, Ms. Jones, had a portfolio with an expected return of 4% and a beta of 1.0. The T-bill rate is 2%. At the end of the year, her