Understanding Alpha and Lambda for Forensic Accounting

Video Transcript 

My name's Robert Bonavito, New Jersey forensic accountant. This video is part of a series of videos where I discuss forensic accounting topics for educational purposes only. If this was a litigated matter, I would take a different approach, have different conclusions based on different facts and circumstances.

My name's Robert Bonavito, New Jersey forensic accountant, and today we're gonna talk about the Greek alphabet, okay? I have two, this is Lambda and this is Alpha. And these are two terms in finance that you're gonna hear quite often if you pay attention. And if you have a stock broker, investment manager, you should always ask 'em what's the Lambda on that stock and what's the Alpha on that stock? Something we use in court, we use to understand businesses, especially if it's a publicly held company.

And sounds...you know, in terms of what's your Alpha, sounds complicated. All Alpha is is your risk adjusted return. For example, if I'm taking a 10% risk by investing in stocks and you earn me 10%, well, you really haven't done anything, right? Because you basically get, you know...you give me the 10% risk that I earned. You should earn 15% or 16%. So when you ask your stockbroker, "Hey, what's your Alpha," they may not know what it is, but hopefully they do. And if they say zero... Like, when you listen to the commentators on TV, they never will tell you what their Alpha is. They'll never say, "Well, so-and-so, you know, has...his portfolio has 6% risk, and he is making 8%." They never say that, but they should because that's how you judge if someone's good.

Now if I go on TV and I say, "I have a 20% return on my stock," and you say, "Wow, 20%'s a lotta money." Well what if I took a 35% risk, right? What if my Alpha's 35%? That's not good. So you really need to know what the risk adjusted return, what's the Alpha is the key word. You know, CNBC, these other...you know, hey, you bring a guy on, I wanna know what his Alpha is. Is there an Alpha? And who did it? Is it verified? Most of the time they're not hitting Alpha. Even if, you know, if they have 7%, 8%, they're not doing Alpha.

And then Lambda is, you know, it's just a...it's used in options a lot to calculate risk. You know, it's a ratio. For example, a hard ratio is more risk. And we'll use that in some of our finance models. You know, if something's very risky, we'll multiply it by six or seven. If it's not, you know, risky, could be, you know, one or even a negative number. But this is a ratio used to adjust risk, and this is what your risk adjusted return should be.

And two terms you may wanna just be familiar with, you know, and when someone's talking to you about their portfolio at a dinner party you say, "Well what's the Alpha? Well, if you earn 10%, what's your Alpha?" Is the risk in that portfolio 12%? Ten percent's not good. If the risk is 8%, 10%'s very good. If you have any questions about this, feel free to email me.