Define alpha and interpretation for performance evaluation.

• A. Alpha is the portfolio's total return relative to a benchmark plus risk.
• B. Alpha is the risk-free rate.
• C. Alpha is the excess return relative to a benchmark given the risk; positive alpha indicates outperformance due to skill.
• D. Alpha is the standard deviation of returns.

Answer: (C)

Alpha measures the extra return a portfolio earns beyond what its level of market risk would predict. In the CAPM framework, the expected return given a portfolio’s beta reflects the compensation for taking on market risk, and alpha is the difference between actual return and that risk-adjusted expectation. A positive alpha means the manager added value through skill or timing beyond simply taking on market risk; a negative alpha indicates underperformance after accounting for risk. It’s not just the raw return relative to a benchmark, since that ignores how much risk was taken. It isn’t the risk-free rate, and it isn’t a measure of volatility like standard deviation. So the idea that alpha is the excess return relative to a benchmark given the risk best captures its meaning for performance evaluation.