Stocks and the market portfolio

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Reference no: EM132584797

In a recent closely contested lawsuit, Apex sued Bpex for patent infringement. The jury came back today with its decision. The rate of return on Apex was rA = 3:1%. The rate of return on Bpex was only rB = 2:5%. The market today responded to very encouraging news about the unemployment rate, and rM = 3%. The historical relationship between returns on these stocks and the market portfolio has been estimated from index model regressions as:

Apex : rA = 0.2% + 1.4*rM

Bpex : rB = -0.1% + 0.6*rM

On the basis of these data, which company do you think won the lawsuit?

ANSWER(?)

Given

rA = 3.1%

rB = 2.5%

rM = 3.0%

Calculations

Apex

Fair expected return = 0.2 + 1.4*3% = 4.40%

Alpha (A) = Actual Return - Fair Expected Return = 3.1% - 4.4% = -1.3%

Alpha is negative = The actual return is underperforming the fair expectation

Bpex

Fair expected return = -0.1% + 0.6*3% = 1.70%

Alpha (B) = 2.5% - 1.7% = 0.8%

Alpha is positive = The actual return is outperforming the fair expectation

Conclusion

Bpex won the lawsuit.

KEY QUESTION

Please explain why you can conclude that Bpex won the lawsuit based on the above.

Reference no: EM132584797

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