What would be the dollar value and rate of return on the market neutral position if the value of the residual turns out to be −4%? If the market return in that month is 5%, where would the plot of the strategy return lie in each panel of Figure 20.1?

Figure 20.1

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Total Return on Hedged Portfolio Excess Rate of Return, r-r 3% 1% A: Unhedged Position a = 2% B: Hedged Position Return on Positive Alpha Portfolio Return for Fairly Priced Assets Alpha = 2% Excess Market Return, r-r Characteristic Line of Your Hedged (30) Portfolio Is Flat <<- a= 2% Characteristic Line of Fairly Priced Zero-Beta Asset Total Market Return, M