Consider a hedge fund specializing in arbitrage strategies involving dual-listed companies and multiple share classes of the same firm. For this exercise you can make the following assumptions: the price spread between twin-stocks A and B fluctuates between -10 % and +10 % but the average value is zero (i.e., the twins have on average the same price). The CAPM betas of each stock pair is also the same. The hedge fund uses a dollar-neutral strategy to buy the relatively inexpensive twin and short the relatively expensive twin. The annualized average return on this arbitrage strategy is 8 % per year after all costs and fees. The standard deviation of the strategy return is 40 % per year. Which of the following statement is the most likely to be true? OA. The CAPM alpha of the strategy after fees is significantly higher than 8 % per year. OB. The CAPM alpha of the strategy after fees is significantly lower than 8% per year. OC. The CAPM alpha of the strategy after fees is close to 8% per year.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Consider a hedge fund specializing in arbitrage strategies involving dual-listed companies and multiple share classes of the same firm. For this exercise you can make the following assumptions: the price spread
between twin-stocks A and B fluctuates between -10 % and +10 % but the average value is zero (i.e., the twins have on average the same price). The CAPM betas of each stock pair is also the same. The hedge
fund uses a dollar-neutral strategy to buy the relatively inexpensive twin and short the relatively expensive twin. The annualized average return on this arbitrage strategy is 8 % per year after all costs and fees.
The standard deviation of the strategy return is 40 % per year. Which of the following statement is the most likely to be true?
O A. The CAPM alpha of the strategy after fees is significantly higher than 8 % per year.
O B. The CAPM alpha of the strategy after fees is significantly lower than 8 % per year.
OC. The CAPM alpha of the strategy after fees is close to 8 % per year.
Transcribed Image Text:Consider a hedge fund specializing in arbitrage strategies involving dual-listed companies and multiple share classes of the same firm. For this exercise you can make the following assumptions: the price spread between twin-stocks A and B fluctuates between -10 % and +10 % but the average value is zero (i.e., the twins have on average the same price). The CAPM betas of each stock pair is also the same. The hedge fund uses a dollar-neutral strategy to buy the relatively inexpensive twin and short the relatively expensive twin. The annualized average return on this arbitrage strategy is 8 % per year after all costs and fees. The standard deviation of the strategy return is 40 % per year. Which of the following statement is the most likely to be true? O A. The CAPM alpha of the strategy after fees is significantly higher than 8 % per year. O B. The CAPM alpha of the strategy after fees is significantly lower than 8 % per year. OC. The CAPM alpha of the strategy after fees is close to 8 % per year.
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