Week 12: Portfolio Performance

Question 1

Explain Dollar weighted returns

Answer 1

Internal rate of return considering the cash flow from or to investment Returns are weighted by the amount invested in each stock

Question 2

Explain time weighted returns

Answer 2

Not weighted by investment amount Equal weighting

Question 3

Explain the two averaging returns formula and how it works

Answer 3

Arithmetic Mean

Question 4

What is the M^2 measure of portfolio performance

Answer 4

Equates the volatility of the managed portfolio with the market by creating a hypothetical portfolio made up of T-bills and the managed portfolio

If the risk is lower than the market, leverage is used and the hypothetical portfolio is compared to the market

Question 5

Explain the complications to measuring performance through the M^2 ratio

Answer 5

Two major problems

1. Need many observations even when portfolio mean and variance are constant
2. Active management leads to shifts in parameters making measurement more difficult

To measure well – You need a lot of short intervals – For each period you need to specify the makeup of the portfolio

Question 6

Exaplin the Limitations of M^2 portfolio performance

Answer 6

1. Assumptions underlying measures limit their usefulness
2. When the portfolio is being actively managed, basic stability requirements are not met
3. Practitioners often use benchmark portfolio comparisons to measure performance