CH18 Flashcards
What is a time-weighted return?
The geometric average where each period’s return has equal weight.
It is calculated using the formula G = (1 + r1) × (1 + r2) × … × (1 + rn)^(1/n) - 1.
What are dollar-weighted returns?
Internal rate of return considering the cash flow from or to investment.
Returns are weighted by the amount invested in each period.
What does the term ‘comparison universe’ refer to?
A set of portfolio managers with similar investment styles used to assess relative performance.
What is the Sharpe Ratio?
A reward-to-volatility ratio, representing excess return to standard deviation.
It is calculated as S = (r_p - r_f) / σ_p.
What is the formula for the Treynor Measure?
The ratio of portfolio excess return to beta: T = (R_p - R_f) / β.
What does the Information Ratio measure?
The ratio of alpha to standard deviation of diversifiable risk.
Fill in the blank: The _______ considers the variance of the market-driven return component.
Variance
What is the purpose of the single index model in performance evaluation?
To measure abnormal performance by comparing to normal performance.
What does the M2 Measure represent?
The return difference between a managed portfolio leveraged to match the volatility of a passive index and the return on that index.
Explain the concept of risk-adjusted performance.
Performance that is measured considering the risk taken to achieve that performance.
True or False: The dollar-weighted average is typically higher than the time-weighted average.
False
What did William Sharpe’s 1992 study reveal about mutual fund performance?
91.5% of variation in return could be explained by the funds’ asset allocations to bills, bonds, and stocks.
What is the significance of alpha in performance measures?
Alpha indicates the excess return of an investment relative to the return of a benchmark index.
Fill in the blank: The _______ is used when choosing among competing portfolios that will not be mixed.
Sharpe Ratio
What is the formula for calculating expected return using the single index model?
E(R_P) = β_P * E(R_M) + α_P
What does a higher Information Ratio indicate?
A higher alpha relative to the amount of risk taken.
What is the relationship between risk and return in the context of performance evaluation?
Higher risk is generally associated with the potential for higher returns.
What does the variance of return on the market represent?
The degree of fluctuation in returns that can be attributed to market movements.
What is Morningstar’s Risk-Adjusted Rating?
A rating system that ranks mutual funds based on risk-adjusted performance and assigns stars accordingly.
Peer groups established based on Morningstar style definitions
What does RAR stand for in mutual fund analysis?
Risk-Adjusted Return
Used to evaluate the performance of funds relative to their risk.
What is a survivorship bias?
An upward bias in average fund performance due to not accounting for failed funds over the sample period.
This can distort the perceived performance of mutual funds.
What is the problem with performance measures for funds?
They can be particularly problematic for funds engaging in active asset allocation.
This is due to the assumption of maintaining a constant level of risk.
True or False: There is strong evidence of persistent market-timing ability.
False
Little evidence exists for consistent market timing success.
What is market timing in investment strategy?
Adjusting asset allocation based on expected changes in market conditions.
This can involve shifting between stocks and bonds or money market instruments.
Fill in the blank: The key to valuing market timing ability is to recognize that perfect foresight is equivalent to holding a _______.
call option on the equity portfolio
This analogy helps in understanding the potential value of market timing.
What is a bogey in performance attribution?
A benchmark portfolio comprised of three indexes with given weights.
It represents the return on an unmanaged portfolio.
What does the bogey return represent?
The return on an unmanaged portfolio.
This is used as a standard for comparing managed portfolios.
What is the significance of weights in a bogey portfolio?
They represent the standard portfolio for the typical risk tolerance of a given type of client or fund category.
What is the relationship between market timing and beta?
Market timing can affect the beta of a portfolio, which measures its volatility relative to the market.
Beta changes can occur with market timing strategies.
What is performance attribution?
The process of evaluating the performance of a portfolio by analyzing the contributions of various factors.
This includes sector allocation and individual security selection.
What does the Sharpe Ratio measure?
The risk-adjusted return of an investment.
A higher Sharpe Ratio indicates better risk-adjusted performance.
What are the challenges in judging market timing ability?
It takes a long time horizon to judge ability and requires assessing the proportions of correct calls: Bull vs. Bear.
Investors must distinguish between luck and skill in market timing.
What does a perfect market timer achieve?
A rate of return that consistently outperforms the market due to accurate market predictions.
This is a theoretical concept as perfect timing is practically unattainable.
What is the effect of changing portfolio composition on performance measurements?
It complicates the assessment of performance due to varying levels of risk taken at different times.
