Alpha is a measure of the returns on investment, which may be either more or less than that of the benchmark index on an exchange.
A risk-adjusted calculation of excess returns, which will be referred to as alpha, incorporates the risk-adjusted returns of the benchmark with the following formula:-
Alpha =Rp- Bp*Rb
Where Rp is returns on the portfolio
Bp is the beta or risk of the portfolio
Rb is the returns on the benchmark
Key: Rf is the risk-free returns in the market
Rp is the returns on the portfolio
a is alpha
b is beta
Systematic risk has to be adjusted against the benchmark returns for computing alpha.
Alpha is mostly used for performance evaluation of fund managers.
If an investment fund generates 5 percent alpha, it means the fund has beaten the benchmark index by 5 percent on a risk-adjusted basis.