Chapter 16: Performance measurement (2)

Question 1

Portfolio risk and return analysis

Answer 1

portfolio risk and return analysis typically involves plotting the overall time-weighted return from a portfolio over a period against the “riskiness” of the portfolio.

It is used to asses whether superior investment performance has been obtained by taking more risk or by superior market and stock selection/timing.

Question 2

Problems with regular risk and return analysis include: (3)

Answer 2

1. creeping changes in portfolio composition
2. a successful investment manager may be treated unfairly by the measurement system.
3. the manager may simply disagree with the market view of a stock’s or market’s prospects and/or the uncertainty attached to those prospects.

Question 3

Changes in the market price of an equity as a measure of success or failure - Additional considerations: (2)

Answer 3

1. dividend income must be allowed for

2. an equity price may be influenced by short-term concerns whereas many investors are more focused on the long term.

Question 4

An investor’s estimate of net present value may differ from the market price due to: (2)

Answer 4

1. differences between the particular investor and the average investor
2. other differences in underlying assumptions between the investor and the market.

Question 5

The CAPM suggests that if capital assets are priced correctly then: (2)

Answer 5

1. returns in excess of the risk-free rate will only be generated from taking risk
2. the risk-adjusted return on capital should be equal to the risk-free rate

Question 6

High risk-adjusted return on capital

Answer 6

Generally, a high risk-adjusted return on capital implies the successful creation of intangible assets and shareholder value.

Question 7

When calculating capital include and value: (4)

Answer 7

1. goodwill from mergers/takeovers
2. internally generated goodwill
3. any other intangible assets
4. all tangible assets

Question 8

When calculating return: (2)

Answer 8

1. add back to profits any investment in creation of new intangible assets and in the expansion and purchase of tangible assets (CAPEX)
2. continue to deduct any expenses incurred defending and servicing existing tangible and intangible assets.