Chapter 11 - Measuring portfolio performance

Question 1

alpha

and the formula

Answer 1

• difference between return expected given a securities beta, and the return it has actually produced
• part of return that cannot be explained by market movements. often referred to as the value added by the fund manager
• actual return - [rf + bi (rm - rf)]

rf is the risk free return

rm is the market return

bi is the beta

Question 2

beta

Answer 2

• market has a beta of 1. the beta of a security reflects the extent it moves up or dowm with the market
• security with a beta of 1 - move with the market, like for like
• secutity with a beta more than 1 - exaggerates the markets movements; move more and in the same direction
• secutiy with a beta of less than 1 (but more than 0) - more stable than the market; move less but in the same direction

Question 3

holding period return

and the formula

Answer 3

• return earned over the period an investment is held, expressed as a percentage of the original cost
• accounts for income recived, capital gain and profit
• (D+V1-V0) / V0
• D is income recived in period
• V0 is price or value at acquisition
• V1 is price on selling (actual or anticipated)

Question 4

sharpe ratio

calculation

what the results mean

Answer 4

• measure of the risk-adjusted return of an investment - measures the excess return for every unit of risk (standard deviatraion)
• (return - risk free return) / standard deviation

reults meaning:

• positive - compensates invetsor for taking risk
• negative - risk free asset would of performed better
• positive returns may only be due to excesive risk

Question 5

information ratio

=

Answer 5

• measures the relative return achieved by an investemnt manager divided by the amouint of risk the manager has taken relative to a benchmark
• risk is the tracking error, which is the standard deviation of the relative returns
• Rp - Rb

______

tracking error

Rp is the portfolio return

Rb is the benchmark return

Question 6

indices

weighting

Answer 6

• can be constructed in different ways. some are more suited for benchamrks, whereas others are better suited to provide short term market movement infotrmation
• market value weighted - FTSE, MSCI and S&P 500. summation of the market values or capitalisations (share price x shares outstanding)
• free float - FTSE. indicies adjusted for free float. it is the number of shares that are available for trading on the stock market, exlcuding controlling shareholders , cross holders, founders shares and gov holdings
• price weighted indicies - Dow Jones. average of current prices divided by divisor. the divsor is adjusted downards if a compny has a stock split, if there was no adjustment, there would be a decline in the index
• unweighted indicies - same as equally weighted indicies. equal investment in each stock is assumed, a percentage rise in the share price will have an equal impact n the index. not used for benchmarks, only academic work

Question 7

money-weighted return (MWR)

=

time-weighted return (MWR)

Answer 7

MWR - measures the return on a portfolio adjusted for cash flows

TWR - measures the return on a portfolio but aims to eliminate the distortions caused by the timing of cash flow. appropriate for benchmark comparison