One year ago, Matt bought 100 shares of ACE Corp. stock for $5,619 including commission
He is about to sell the ACE stock for $6,528 net of commissions. When he made the purchase the S&P 500 index was at 907; now it is 1070. The beta of ACE stock is 0.98, and the market's risk-free rate is 4.0%. No dividends were paid. Based on Jensen's measure, did Matt make a good purchase?
What will be an ideal response?
Answer:
HPR (ACE) = ($6,528 - $5,619)/$5,619 = 16.18%
HPR (S&P 500) = (1070 - 0907)/907 = 17.97%
Jensen's Measure = (16.18% - 4.0%) - [0.98 (17.97% - 4.0%)]
= 12.18% - 13.69% = -1.51%
Therefore, Matt made a bad investment, since the stock has an excess return of -1.51% which means the stock earned 1.51% less than it should have on a risk-adjusted basis.
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