Portfolio Management and Measurements

Question 1

Markowitz asserts that investors should base their portfolio decisions solely on two variables:

Answer 1

Expected returns and standard deviations

Question 2

Portfolio diversification is most effective when the correlation coefficient is

Answer 2

Less than zero

Question 3

Ways to calculate return for a portfolio

Answer 3

• Holding Period
• Dollar-weighted Return (Internal Rate of Return)
• Time-weighted Return
• Annualized Returns

Question 4

CAPM based measures of portfolio performance

Answer 4

Sharpe ratio
Treynor ratio
Jensen’s ratio

Question 5

How are the two kinds of risk measured?

Answer 5

• Portfolio’s market measure by its Beta
• Portfolio’s total risk, measured by its SD

Question 6

Sharpe Ratio

Answer 6

Measures risk premium per unit of risk: Single parameter portfolio performance index calculated from both risk and return statistics, considers total risk for the appropriate risk statistic

Question 7

Treynor Ratio

Answer 7

Ranks the desirability of assets in Beta-E(r) space, may be preferred because systematic risk is more relevant than total risk in certain applications and can be used to compare individual assets and portfolios

Question 8

Jensen’s alpha

Answer 8

Measures risk-adjusted returns and is useful in evaluating portfolio and individual assets

Question 9

Coefficient of determination and relevancy of benchmark

Answer 9

If R^2 >.7, use betaor any of the beta formulas (alpha, CAPM, Treynor), if <.7, use SD statistic and formulas

Question 10

The statistical measure of co-movement that is standardized on a scale of -1.0 to 1.0 is known as

Answer 10

correlation coefficient has a standardized scale

Question 11

If a portfolio manager is looking to add diversifying securities into their portfolio, which of the following securities would be best to add?

Answer 11

Negatively correlated securities

Question 12

Barry purchased 1,250 shares of FIB for $17,700. FIB stock is currently paying $900 of annual dividend income to Barry. Dividends are expected to grow 4.25% annually. FIB stock is currently priced at $80.

Identify Barry’s required rate of return.

Answer 12

Use the required rate of return formula for dividend-paying securities to solve:

r = (D1 ÷ P) + g

r = required rate of return
D1 = Dividend (D0 x (1 + g))
P = Price of the stock
g = fixed, stable growth rate

Dividends are expected to grow 4.25% annually.

The dividend/share is $0.72 ($900/1,250 shares). FIB stock is currently priced at $80.

r = [(0.72(1.0425)) ÷ 80] + 0.0425

r = 0.009383 + 0.0425

r = 0.05188, or 5.19%