Assume that the economy has three types of people. 20% are fad followers, 75% are passive investors, and 5% are informed traders. The portfolio consisting of all informed traders has a beta of 1.4 and an expected return of 16%. The market has an expected return of 10% and the risk-free rate is 4%. The alpha for the informed investors is closest to:

3.6%

Explanation:

The computation of the alpha for the informed investors is shown below:

As we know that

Expected rate of k = Risk free rate of return + Beta * (Market rate of return - Risk free rate of return) + Alpha

16% = 4% + 1.4 * (10% - 4%) + Alpha

16% = 4% + 8.4% + Alpha

16% = 12.4% + Alpha

So,

Alpha = 3.6%

We simply applied the above formula to determine the alpha