Chapter 11-the performance of investments

Question 1

What is the holding period rate of return for a portfolio initially worth £384,000, now valued at £426,500 and which had a £16,000 withdrawal?

Answer 1

HPR = (change in value + withdrawals) / original value x 100

(426,500 - 384,000 + 16,000) / 384,000
x 100

= 15.23%

Question 2

What is the purpose of the money weighted rate of return and the time weighted rate of return?

Answer 2

The money weighted rate of return is used to calculate the valid rate of return for a portfolio, while the time weighted rate of return is used to compare performances of portfolios by eliminating the distortions caused by the timings of cash flows.

Question 3

What does the Sharpe ratio measure?

Answer 3

The Sharpe ratio measures to return above the risk free rate for every unit of risk taken (as measured by the standard deviation). It identifies whether the return on a portfolio is due to the skilful decisions of the manager or the result of taking excessive risk.

Question 4

What does Jensen’s alpha measure?

Answer 4

Jensen is alpha measures the difference between the return you would expect from a security, given it’s beta, and the return it has actually produced. For a portfolio, it is the return that is independent of the market and is a measure of the managers stock picking skills.

Question 5

A .what does the information ratio measure?

B. What does a positive information ratio indicate?

Answer 5

A. The information ratio measures the relative return achieved by an investment manager divided by the risk taken relative to a benchmark (tracking error).

B. A positive information ratio indicates that the manager has added value through active management

Question 6

Formula for Holding period return

Answer 6

(Income revived during period + value of portfolio at end of period - value of portfolio at start of period)/ value of portfolio at start of period

Question 7

Formula for money waited rate of return

Answer 7

= D + V1 - V0 - C / V0 + ((C x n)/12)

(Income revived during period + value at end of period - value at start or period - new money introduced during) / value at start of period + ((money introduced during period x n)/12)

Question 8

Formula for Time weighted rate of return

Answer 8

1 + TWR = (holding period return of each sub period + 1) all added together going on for n

1 + TWR = (1 + r) + ….. (1 +rn)

Question 9

Formula for the Sharpe ratio

Answer 9

Rated return on investment – risk free return/standard deviation of the return on the investment

Question 10

Formula for Jensen’s alpha

Answer 10

Actual portfolio return – (risk free rate of return + better of the fund or portfolio (market return-risk free rate of return))

Question 11

Formula for the information ratio

Answer 11

Portfolio or fund return – benchmark return/tracking error

Question 12

What does a positive or negative alpha mean

Answer 12

Positive - security has performed better than would be predicted given its beta

Negative - performed worst than expected given it’s beta