Equity Formulas Flashcards
ALPHA =
Portfolio Return - [Risk Free + Beta x (Average Return - Risk Free Return)}
What does Alpha Measure?
The difference between the return that would be expected by a fund manager, given its Beta, compared with actual return. This is sometimes referred to as “Value Added”
SHARPE =
Portfolio Return - Risk Free Return /
Volatility
What does Sharpe Measure?
The Sharpe ratio is a measure which calculates the level of funds return over and above a notional risk-free investment such as cash.
Useful when comparing similar funds or portfolios the one with the higher ratio has generally achieved more return while taking on no more risk than the others.
There is no definition of a good or bad Sharpe beyond the thought that a fund with a negative Sharpe ratio would have been better off investing in risk free products.
Information Ratio =
Portfolio Return - Benchmark Return /
Tracking Error
What does Information Ratio Measure?
The information ratio assesses the degree to which a fund manager uses skill and knowledge to enhance returns.
It is generally considered that the higher the number the better, with 0.75 reflecting a very good performance and 1.00 outstanding performance.
BETA
What is Beta?
Beta is a measure of how closely the performance of the fund has mirrored its chosen benchmark. If the Beta is 1 then it is exactly the same. Beta of 1.5 implies that a fund has risen/fallen by 50% more than the benchmark.
Passively managed funds aim for a Beta of 1
Volatility
3 Year Standard Deviation is used to measure volatility.
1 Standard Deviation = 68%
2 Standard Deviation = 95%
3 Standard Deviation = 99%
