Stock C has a RADR of 17.5% and Stock D has a RA attributes, Stock C should have

Question

Stock C has a RADR of 17.5% and Stock D has a RA attributes, Stock C should have a CAPM beta of 1.35 and Stock D should ha beta of 1.19. Calculate the Treynor Measure (TM) and Jenha DR of 12.6%. Based on its risk security, assuming a risk-free rate of 3.4% and a market rate s alpha (Alpha) for each of 12.2%. TM (C): (xx.xx%) TM (D): Alpha (C), (xx.xx%) Alpha (D): (xxxx%) Circle the correct answer: Security C is: underpriced Security D is: underpriced correctly priced overpriced correctly priced overpriced

Explanation / Answer

Treynor model
Stock C has return = 17.5%, Stock D has return = 12.6%
Stock C has Beta = 1.35, Stock D has Beta = 1.19
Market return = 12.2%, Risk free rate = 3.4%
Treynor model index for mutual fund = Return on portfolio - Risk free rate / Beta
Treynor model index for Stock C = 17.5% - 3.4% / 1.35 = 10.44%
Treynor model index for Stock D = 12.6% - 3.4% / 1.19 = 7.73 %

Jensen`s alpha model
Jensen`s alpha = Expected return - Required return
Jensen`s alpha = Return on portfolio - ( Risk free rate + Beta ( Return on market - Risk free rate )
Jensen`s alpha for Stock C = 17.5 - ( 3.4 + 1.35 ( 12.2 - 3.4 ) ) = 17.5 - (3.4 + 11.88) = 17.5 - 15.28 = 2.22
Jensen`s alpha for Stock D = 12.6 - ( 3.4 + 1.19 ( 12.2 - 3.4 ) ) = 12.6 - (3.4 + 10.472) = 12.6 - 13.872 = -1.272
As Jensen`s alpha for Stock C is Positive i.e., 2.22, it is outperformed and underpriced
As Jensen`s alpha for Stock D is Negative i.e., -1.272, it is undervalued and overpriced

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