Question of the Week

Stocks with a positive alpha are considered to be underpriced, while those with a negative alpha are thought to be overpriced. If you are analyzing the alpha of a stock, you are most likely concerned with the:

a) Risk-adjusted return
b) Sharpe ratio
c) Price-to-earnings ratio
d) Internal rate of return

Answer:

The correct answer is a):

The risk-adjusted return attempts to measure the risks taken to achieve a desired return. Alpha refers to the excess return over the expected return for the level of risk implied by the security’s beta. Risk-adjusted return is usually measured by assigning the security an alpha rating. The sharpe ratio uses standard deviation as a performance measure.