L2 SH: M2 and T2

Question 1

Give the equation for Alpha

Answer 1

a = rp - (rf + B(rm-rf))

the section in the brackets is CAPM, if this is smaller than the return on the portfolio the the portfolio is giving a better return than the market and a will be positive

Question 2

Plot the CAPM line on the graph B (y) x expected return. What significance does this have?

Answer 2

Alpha is measured by a B-value therefore you could have many portfolios with different returns but the same alpha value

Question 3

Describe the M2 measure

Answer 3

Modigliani risk-adjusted performance (also known as M2, Modigliani–Modigliani measure or RAP) is a measure of the risk-adjusted returns of some investment portfolio.

It measures the returns of the portfolio, adjusted for the risk of the portfolio relative to that of some benchmark (e.g., the market)

Question 4

How is M2 similar to Sharpe Ratio

Answer 4

Its derived from the Sharpe ratio but it has the advantage of being in % units - more intuitive the interpret