Portfolio Performance Evaluation

Question 1

Match the performance measure and application.

a) Treynor measure
b) Information ratio
c) Sharpe ratio

i) When choosing among portfolios competing for the overall risky portfolio
ii) When ranking many portfolios that will be mixed to form the overall risky portfolio.
iii) When evaluating a portfolio to be mixed with the benchmark portfolio

Answer 1

a) - ii)
b) - iii)
c) - i)

Question 2

Which of the performance measures does the following description describe?

“Expresses the ratio of the average excess return of the portfolio in respect to the volatility of the portfolio. This indicates the volatility of the portfolio and measures the reward to total volatility trade-off.”

a) Treynor measure
b) Information ratio
c) Sharpe ratio
d) Jensen’s alpha

Answer 2

c) Sharpe ratio

Question 3

Which of the performance measures does the following description describe?

“Expresses the ratio of the average excess return of the portfolio in respect to the weighted average beta of the portfolio (systematic risk). It also gives the slope of the SML going through the origin to the specific portfolio.”

a) Treynor measure
b) Information ratio
c) Sharpe ratio
d) Jensen’s alpha

Answer 3

a) Treynor measure

Question 4

Which of the performance measures does the following description describe?

“The relation of the specific point relative to SML. “

a) Treynor measure
b) Information ratio
c) Sharpe ratio
d) Jensen’s alpha

Answer 4

d) Jensen’s alpha

Question 5

Which of the performance measures does the following description describe?

“Divides the alpha of the portfolio by the nonsystematic risk. It measures abnormal return per unit of risk than in principle could be diversified away by holding a market index portfolio. It is another version of a reward-to-risk ratio. The measure quantifies the trade-off between alpha and diversifiable risk. “

a) Treynor measure
b) Information ratio
c) Sharpe ratio
d) Jensen’s alpha

Answer 5

b) Information ratio

Question 6

If the portfolio represents the entire risky investment, i.e., if investor is considering allotting capital in asset A or B, and the given decision would completely change the total volatility profile of the investor’s wealth, then use the ______.

a) Treynor measure
b) Information ratio
c) Sharpe ratio
d) Jensen’s alpha

Answer 6

c) Sharpe ratio

Question 7

If the portfolio is one of many combined into a larger investment fund, use the _______ or _________. The __________ is appealing because it weighs excess returns against systematic risk. On the other hand, ______ makes inference (conclusion (??)) easier. The both of them can be used, due to the fact that they both account for beta.

a) Treynor measure
b) Information ratio
c) Sharpe ratio
d) Jensen’s alpha

Answer 7

d) Jensen’s alpha; a) Treynor measure; a) Treynor measure; d) Jensen’s alpha

Question 8

Portfolios with _____ betas are called highly ______ or aggressive because they are very responsive to economywide developments. _____ beta portfolios are described as _____.

a) High, cyclical, Low, defensive
b) Low, cyclical, High, defensive
c) High, noncyclical, Low, aggressive
d) Low, noncyclical, High, aggressive

Answer 8

a) High, cyclical, Low, defensive

Question 9

_______ involves shifting funds between a market-index portfolio and a safe asset, depending on whether the market index is expected to outperform the safe asset.

a) Stock picking
b) Stock timing
c) Market timing
d) Investing

Answer 9

c) Market timing

Question 10

Which 3 components does a common attribution decompose performance into?

Answer 10

• Broad asset market allocation choices across equity, fixed income and money markets
• Industry (sector) choice within each market
• Security choice within each sector.

Question 11

What is true about the bogey (several answers)?

a) It is the difference in returns between a managed portfolio and a selected benchmark portfolio
b) It is designed to measure the returns the portfolio would earn if he/she were to follow a completely passive strategy.
c) It involves shifting funds between a market-index portfolio and a safe asset, depending on whether the market index is expected to outperform the safe asset
d) Any departure of the manager’s return from the passive benchmark must be due to either asset allocation bets or security selection bets.
e) It is the difference in returns between a managed portfolio of manager A and a managed portfolio of manager B

Answer 11

a) It is the difference in returns between a managed portfolio and a selected benchmark portfolio
b) It is designed to measure the returns the portfolio would earn if he/she were to follow a completely passive strategy.
d) Any departure of the manager’s return from the passive benchmark must be due to either asset allocation bets or security selection bets.

Question 12

True or false.

Superior performance relative to the bogey is achieved by overweighting investments in markets that turn out to perform bad and by underweighting those in good performing markets.

Answer 12

False.

Superior performance relative to the bogey is achieved by overweighting investments in markets that turn out to perform WELL and by underweighting those in POORLY performing markets.

The contribution of asset allocation to superior performance equals the sum over all markets of the excess weight (sometimes called the active weight in the industry) in each market times the return of the index in the market.

Question 13

What is the tracking error?

a) It involves shifting funds between a market-index portfolio and a safe asset, depending on whether the market index is expected to outperform the safe asset
b) The internal rate of rate (IRR) of an investment
c) The difference between the return on a managed portfolio and that of a benchmark portfolio against which the manager is evaluated.
d) The set of money managers employing similar investment styles and risk characteristics used as a benchmark for assessing the relative performance of a portfolio manager.

Answer 13

c) The difference between the return on a managed portfolio and that of a benchmark portfolio against which the manager is evaluated.

Question 14

What is the Comparison universe?

a) It involves shifting funds between a market-index portfolio and a safe asset, depending on whether the market index is expected to outperform the safe asset
b) The internal rate of rate (IRR) of an investment
c) The difference between the return on a managed portfolio and that of a benchmark portfolio against which the manager is evaluated.
d) The set of money managers employing similar investment styles and risk characteristics used as a benchmark for assessing the relative performance of a portfolio manager.

Answer 14

d) The set of money managers employing similar investment styles and risk characteristics used as a benchmark for assessing the relative performance of a portfolio manager.

Question 15

What is the dollar-weighted rate of return?

a) It involves shifting funds between a market-index portfolio and a safe asset, depending on whether the market index is expected to outperform the safe asset
b) The internal rate of rate (IRR) of an investment
c) The difference between the return on a managed portfolio and that of a benchmark portfolio against which the manager is evaluated.
d) The set of money managers employing similar investment styles and risk characteristics used as a benchmark for assessing the relative performance of a portfolio manager.

Answer 15

b) The internal rate of rate (IRR) of an investment

Question 16

The geometric average (time-weighted return) on a risky investment is always _____ than the corresponding arithmetic average.

Answer 16

Lower

The arithmetic average is always greater than or equal to the geometric average. The greater the dispersion, the greater the difference – i.e., the higher the arithmetic average relative to geometric average.

Question 17

In terms of ‘forward looking’ statistics, which estimate of expected rate of return is the better?

a) Geometric average return
b) Dollar-weighted return
c) Time-weighted return
d) Arithmetic average return.

Answer 17

d) Arithmetic average return.

Question 18

If the Jensen’s alpha generates a negative value, what is true (several answers)?

a) The investor’s required return in order to compensate for taking on the systematic risk connected to allocation funds to the portfolio is not met by its expected return.
b) The expected return will be maid of (expected return + numerical Jensen’s alpha).
c) The investor should invest in the portfolio
d) The investor should not invest in the portfolio

Answer 18

a) The investor’s required return in order to compensate for taking on the systematic risk connected to allocation funds to the portfolio is not met by its expected return.
b) The expected return will be maid of (expected return + numerical Jensen’s alpha).
d) The investor should not invest in the portfolio

Question 19

If you invest only in T-bills and one portfolio, the _____ is the appropriate criteria.

a) Treynor measure
b) Information ratio
c) Sharpe ratio
d) Jensen’s alpha

Answer 19

c) Sharpe ratio

Question 20

How can alpha be identified from regression estimates?

Answer 20

Alpha is the regression INTERCEPT

Question 21

How can beta be identified from regression estimates?

Answer 21

Beta is the SLOPE COEFFICIENT OF THE regression equation

Question 22

Match measure and claim.

a) Treynor measure
b) Information ratio
c) Sharpe ratio
d) Jensen’s alpha

i) This is the only risky asset to be held by the investor
ii) This stock will be mixed with the rest of the investor’s portfolio, currently composed solely of holding in the market-index fund.
iii) This is one of many stocks that the investor is analyzing to from an actively managed stock portfolio

Answer 22

i) - c) Sharpe ratio
ii) - a) Treynor measure or d) Jensen’s alpha
iii) - a) Treynor measure

Question 23

The stock picking ability is indicated by _________, while the ______________ measures market timing.

Answer 23

Alpha (intercept), coefficient multiplying square.

Question 24

A postive alpha, indicates ______ stock picking.

Answer 24

good

Question 25

A _____ curve indicates positive market timing. A _______ curve indicates negative market timing.

Answer 25

Convex
Concave

Lines that become steeper as you move to the right along the horizontal axis show good timing ability. The steeper slope shows that the manager maintained higher portfolio sensitivity to market swings (i.e., a higher beta) in periods when the market performed well. This ability to choose more market-sensitive securities in anticipation of market upturns is the essence of good timing. In contrast, a declining slope as you move to the right means that the portfolio was more sensitive to the market when the market did poorly and less sensitive when the market did well. This indicates poor timing.

Question 26

Which of the following is NOT a determinants for stockholding (i.e., whether to hold stocks and how many stocks to hold) according to John Heaton and Debora Lucas (2000)?

a) Net worht
b) Market volatility
c) Relative business
d) Age

Answer 26

WRONG: b) Market volatility is NOT a determinant for stockholding.
According to John Heaton and Debora Lucas (2000), significant explanatory variables for stockholding include:
• Net worth: wealthier people hold a larger proportion of stocks.
• Relative business: if you are a business man owning a company, you are less likely to hold stocks, because you are already running risk by running company - i.e., you are not incentivized to increase the risk of your portfolio by adding single stocks.
• Age of respondents: there is a positive coefficient, indicating that the older you are, the more likely you are to hold stocks.

Question 27

Which two ways are most commonly utilized when measuring Average Portfolio Return:

a) time-weighted (average) returns
b) internal rate of return
c) dollar/ money- weighted returns
d) risk-adjusted return
e) CAPM

Answer 27

a) time-weighted (average) returns

c) dollar/ money- weighted returns

Question 28

When measuring risk-adjusted portfolio performance, which measure is most appropriate when the portfolio under evaluation represents the active portfolio to be optimally mixed with the passive portfolio?

a) Sharpe ratio
b) Treynor measure
c) Jensen’s Alpha
d) Information Ratio

Answer 28

d) Information Ratio is most approriate when measuring a portfolio that represents the active portfolio to be optimally mixed with the passive portfolio.

Question 29

True or false.

The evaluation process of portfolio returns is commonly very “noisy”. Therefore, even if the return distribution is stable with a constant mean and variance, many observations and long sample periods are required to eliminate the effect of the “luck of the draw” from the evaluation process.

Answer 29

True.

Think of the example with S&P 500 index compared to the The Markowill Group performance. Here, we looked at the difference in relative performance of the Markowill group across horizons (quarter, 1Y, 3Y & 5Y).

Question 30

Following statement is NOT true about market timing:

a) involves movement of asset allocation e.g., (stocks or fixed income securities) and cash, so that the proportion of stocks in your portfolio changes tactically over time
b) entails active investment pursuing stock pricing
c) is mostly pursued by advocates of the efficient market hypothesis
d) actively managed portfolios (which is the case with market timing) make it difficult to assess performance, since it leads to shifting mean and risk, and an ever-changing portfolio beta

Answer 30

c) is mostly pursued by advocates of the efficient market hypothesis
Strong belief of EMH entails lack of belief in the ability to beat the market. Therefore, such investors would not attempt to pursue market timing.

Question 31

Asset allocation in which the investment in the market is increased if one forecasts that the market will outperform T-bills. This is active investing, and is referred to as:

a) market timing
b) tracking error
c) bogey
d) comparison universe

Answer 31

a) Market timing: Asset allocation in which the investment in the market is increased if one forecasts that the market will outperform T-bills. This is active investing.
• Market timer: An investor who speculates on broad market moves rather than on specific securities.

Question 32

An average (often a geometric average) of the period-by-period holding-period returns of an investment, which is calculated as the product of the return for each period to the power of 1/n, is referred to as:

a) time-weighted average
b) tracking error
c) dollar-weighted average
d) comparison universe

Answer 32

a) time-weighted average

Question 33

The internal rate of return on an investment is also referred to as:

a) time-weighted average
b) tracking error
c) dollar-weighted average rate of return
d) comparison universe

Answer 33

c) dollar-weighted average rate of return = IRR

Question 34

When computing the parameter of average return, we always use _____, while we use the ____ when computing the increase in wealth.

a) Arithmetic metric average return; geometric average return
b) Geometric average return; arithmetric average return

Answer 34

When computing the parameter of average return, we always use ARITHMETRIC AVERAGE RETURN, while we use the GEOMETRIC AVERAGE RETURN when computing the increase in wealth.

Question 35

True or false.

The time weighted return differs from money-weighted return in that it puts equal weight on each period, while the money-weighted return puts a different weight on periods on the basis of the in- and outflows during each period.

Answer 35

True

Question 36

If the alpha (jensen’s aplha) of portfolio A (under consideration) is equal to 1.4%, while the expected return on portfolio A is equal to 12%, which of the statements are then NOT true?

a) Portfolio A would allow the investor to gain additional 1.4% of return
b) The required return in order to compensate for taking on the systematic risk connected to allocating funds in portfolio A is met and exceeded
c) The required return in order for the investor to allocate assets in portfolio A is equal to 1.4%
d) the required return in order for the investor to allocate assets in portfolio A is equal to 10.6%

Answer 36

WRONG: c) The required return in order for the investor to allocate assets in portfolio A is equal to 1.4%
INSTEAD: d) the required return in order for the investor to allocate assets in portfolio A is equal to 10.6%:

Expected return - jensen’s alpha = required return for the investor:
12% - 1.4% = 10.6%

Question 37

If the alpha (jensen’s aplha) of portfolio B (under consideration) is equal to -0.2%, while the expected return on portfolio B is equal to 16%, which of the statements are then TRUE?

a) Portfolio B would allow the investor to gain additional 0.2% of return
b) The required return in order to compensate for taking on the systematic risk connected to allocating funds in portfolio B is met and exceeded - therefore, portfolio B would be a good investment
c) The required return in order for the investor to allocate assets in portfolio B is equal to 16.2%
d) the required return in order for the investor to allocate assets in portfolio B is equal to 0.2%

Answer 37

CORRECT: c) The required return in order for the investor to allocate assets in portfolio B is equal to 16.2%

All other answers are wrong.

Portfolio B would NOT allow the investor to meet the required return: with the negative alpha, it means that the investor’s required return in order to compensate for taking on the systematic risk connected to allocating funds in portfolio B is NOT met by its expected return of 16%. In this case, the investor would in fact require: 16%+0.2%=16.2%. Thus, he/she should not invest in portfolio B.