CPS Performance Measurement and Evaluation 1 — Questions and Answers
Question 1: The Sharpe Ratio measures which of the following?
- Excess return per unit of total risk (standard deviation) (Correct answer)
- Excess return per unit of systematic risk (beta)
- Portfolio alpha relative to a benchmark
- The percentage of return explained by the market
Correct 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.
Question 2: The Treynor Ratio differs from the Sharpe Ratio in that it uses which measure of risk in its denominator?
- Standard deviation
- Semi-deviation
- Beta (Correct answer)
- Tracking error
Correct 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.
Question 3: When evaluating a portfolio manager's skill in selecting individual securities, which metric is most directly appropriate?
- Sharpe Ratio
- Jensen's Alpha (Correct answer)
- Standard Deviation
- Tracking Error
Correct 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.
Question 4: Time-weighted return (TWR) is preferred over money-weighted return (MWR) primarily when:
- Evaluating manager performance independent of client cash flows (Correct answer)
- Measuring total wealth accumulation for a specific investor
- Calculating the internal rate of return on an investment
- Comparing portfolios with very similar cash flow patterns
Correct 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.
Question 5: 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?
- 0.80
- 1.00
- 1.20 (Correct answer)
- 1.50
Correct answer: 1.20
Beta = (portfolio σ / market σ) × correlation = (15/10) × 0.8 = 1.2, indicating the portfolio is more volatile than the market.
Question 6: Which of the following best describes the primary purpose of selecting an appropriate benchmark for a portfolio?
- To ensure the portfolio outperforms all competing portfolios
- To provide a relevant standard for evaluating manager performance (Correct answer)
- To guarantee a minimum return for investors
- To automatically reduce the portfolio's overall risk
Correct 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.
Question 7: R-squared (R²) in portfolio performance analysis measures:
- The percentage of portfolio return variation explained by benchmark movements (Correct answer)
- The portfolio's risk-adjusted return relative to the risk-free rate
- The manager's ability to generate consistent alpha over time
- The correlation between two different managed portfolios
Correct 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).
CPS Performance Measurement and Evaluation 1
The Sharpe Ratio measures which of the following?