Risk Free Returns / Measures Flashcards
Why does risk adjusted return matter?
Investors are risk averse, and therefore given same return, they will take portfolio with less risk
To be considered a risk free asset, what two conditions must be met
1) No Default Risk
2) No reinvestment risk
What is most commonly used as a risk free asset / rate
3 Month T Bill Yield
What does the Sharpe Ratio do?
Calculates return in excess of the risk free rate
What is the formula for the sharpe ratio?
(Rp-Rf)/Vol
What is better, a higher or lower sharpe ratio?
Higher is better - denotes that there is less volatility to withstand
What is Jensen’s Alpha?
Measures performance against a benchmark return (CAPM)
Measures whether a portfolio generates excess return vs its expected performance
What can Jensen’s alpha be used to do?
See where a portfolio falls on the SML
can be in-line, above or below
What is the formula for Jensen’s alpha?
Rp-(Rf+B(Rm-Rf)
Rp is actual portfolio return (the rest of the expression calculates the expected CAPM return)
What ratio is similar to the Sharpe Ratio?
The Information Ratio (IR)
What is the information ratio?
Measures the return on a portfolio vs benchmark and takes into account risk taken to achieve those returns
measures the skill of a manager
What is for formula for the Information Ratio?
IR = (Ra - Rb) / (SDa - SDb)
Where a is portfolio and b is benchmark
What is active share?
measures similarity between fund and benchmark
What does an active share of 0% show?
Identical to benchmark (e.g. fund is a tracker)
What does an active share of 100% show?
No holdings in common between fund and benchmark
