Return Concepts

Question 1

EX ANTE ALPHA

Answer 1

Expected (ex ante) alpha = Expected return – Required return

Question 2

EX POST ALPHA

Answer 2

Realized (ex post) alpha = Actual holding-period return –

Contemporaneous required return

Question 3

Investor’s expected return has 2 components :

Answer 3

• Required return

- Return from the convergence of price to estimated intrinsic value

Question 4

ERP (GGM estimate)

Answer 4

GGM equity risk premium = market dividend yield
+ long-term market earnings growth
– long-term bond yield

Question 5

ERP (macroeconomic estimate)

Answer 5

Equity risk premium = [(1 + expected inflation) x
(1 + expected growth in real EPS) x
(1 + expected growth in P/E ratio) x
(1 + expected income component)] –
Expected risk free return

Question 6

Adjusted BETA

Answer 6

Adjusted beta = (2/3) (Unadjusted beta) + (1/3) (1.0)

Question 7

Unlevered BETA

Answer 7

Beta (bench) * 1 / ( 1 + D/E)

Question 8

Lever back BETA

Answer 8

Beta U * (1 + D’/E’)

Question 9

FAMA FRENCH MODEL

Answer 9

i = RF + βi mkt RMRF + βi size SMB + βi value HML

Question 10

Pastor-Stambaugh Model (PSM)

Answer 10

i = RF + βi mkt RMRF + βi size SMB + βi value HML + βi

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