Performance Measurement and Evaluation Flashcards

The Sharpe Ratio measures which of the following?

Answer: Excess return per unit of total risk (standard deviation)

The Sharpe Ratio calculates excess return (portfolio return minus risk-free rate) divided by the portfolio's standard deviation, representing total risk.

The Treynor Ratio differs from the Sharpe Ratio in that it uses which measure of risk in its denominator?

Answer: Beta

The Treynor Ratio uses beta (systematic risk) as its denominator, making it appropriate for evaluating well-diversified portfolios where unsystematic risk has been eliminated.

When evaluating a portfolio manager's skill in selecting individual securities, which metric is most directly appropriate?

Answer: Jensen's Alpha

Jensen's Alpha measures the excess return above or below the CAPM-predicted return, directly indicating how much value the manager added through security selection.

Time-weighted return (TWR) is preferred over money-weighted return (MWR) primarily when:

Answer: Evaluating manager performance independent of client cash flows

TWR eliminates the distorting impact of external cash flows, making it the standard method for fairly evaluating a portfolio manager's performance independent of client deposit and withdrawal timing.

A portfolio has a standard deviation of 15% and the market has a standard deviation of 10%. If the correlation between them is 0.8, what is the portfolio's beta?

Answer: 1.20

Beta = (portfolio σ / market σ) × correlation = (15/10) × 0.8 = 1.2, indicating the portfolio is more volatile than the market.

Which of the following best describes the primary purpose of selecting an appropriate benchmark for a portfolio?

Answer: To provide a relevant standard for evaluating manager performance

A properly chosen benchmark reflects the manager's investment universe and style, providing a meaningful comparison standard for performance evaluation.

R-squared (R²) in portfolio performance analysis measures:

Answer: The percentage of portfolio return variation explained by benchmark movements

R-squared indicates what proportion of a portfolio's return variability can be attributed to movements in the benchmark, ranging from 0% (no relationship) to 100% (perfect tracking).