Performance Management and Risk Measures Quiz

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Questions and Answers

What does the allocation effect measure?

The manager's total value-added performance

Manager's ability to time the market segments effectively

Manager's decision to over- or underweight a particular market segment (correct)

Manager's ability to create specific market segment portfolios

How is the allocation effect calculated?

[(Rpi − Rbi ) + (Wpi - Wbi )]

[(Wpi - Wbi ) * (Rbi − Rb)] (correct)

[(Rpi − Rbi ) * (Wpi - Wbi )]

[Wpi - Wbi ] / [Rbi − Rb]

What is good timing skill a matter of, according to the given text?

Timing the market segments effectively

Creating specific market segment portfolios

Balancing the portfolio weight and benchmark weight

Investing more money in market segments producing greater-than-average returns (correct)

What does the selection effect measure?

Manager's ability to create specific market segment portfolios Signup and view all the answers

How is the selection effect calculated?

[Rpi − Rbi ] * [Wpi - Wbi ] Signup and view all the answers

What is the manager's total value-added performance according to the given text?

The sum of allocation and selection effects Signup and view all the answers

Which factor is important for good timing skill, based on the text?

Market segment performance relative to benchmark return Signup and view all the answers

What does the term 'Wpi - Wbi' represent in the allocation effect equation?

'Portfolio weight – Benchmark weight' Signup and view all the answers

'Rpi − Rbi' in the selection effect equation represents:

'Portfolio return – Benchmark return' Signup and view all the answers

'(Benchmark weight) * (Portfolio return – Benchmark return)' in the selection effect equation calculates:

'Selection Effect' Signup and view all the answers

Which of the following is an essential attribute of a fund manager?

The ability to derive above-average returns for a given risk class Signup and view all the answers

What is the main goal of superior security selection by a fund manager?

To find undervalued securities Signup and view all the answers

What is the primary purpose of attribution analysis in performance measurement?

To determine the impact of market timing on portfolio returns Signup and view all the answers

What differentiates allocation effects from selection effects in attribution analysis?

Allocation effects relate to changes in asset allocation, while selection effects relate to security choices Signup and view all the answers

What is the significance of completely diversifying a portfolio relative to its benchmark portfolio?

It eliminates unsystematic risk Signup and view all the answers

Which factor contributes to the actual return produced by a manager over an investment horizon?

The return that should have been earned given the capital commitment and the amount of risk in the portfolio Signup and view all the answers

What can lead to superior risk-adjusted returns for a fund manager?

Superior timing and security selection Signup and view all the answers

What are the two main considerations in performance management?

Risk-adjusted measures and attribution analysis Signup and view all the answers

What is the desired attribute of a completely diversified portfolio in relation to its benchmark portfolio?

Perfectly correlated with the fully diversified benchmark portfolio Signup and view all the answers

What contributes to deriving above-average returns for a given risk class as a fund manager?

The ability to diversify the portfolio completely to eliminate unsystematic risk Signup and view all the answers

Which method does not contribute to evaluating expected returns?

Performance assessment Signup and view all the answers

What are the limitations of peer group comparisons in evaluating expected returns?

Both a and b Signup and view all the answers

What does portfolio drawdown measure?

How well the manager protected investors against losses Signup and view all the answers

Which ratio measures risk premium per unit of risk?

Sharpe Ratio Signup and view all the answers

What does Treynor Ratio measure?

Portfolio's return in excess of the risk-free rate per unit of beta Signup and view all the answers

What does Information Ratio measure?

Average return in excess of a benchmark portfolio divided by the tracking error Signup and view all the answers

What does Jensen Measure calculate?

Signup and view all the answers

How can risk-adjusted performance be computed relative to any multifactor model?

Through attribution analysis Signup and view all the answers

What is the aim of Sharpe Ratio?

To measure risk premium per unit of risk Signup and view all the answers

What is one limitation of peer group comparisons?

Difficulty in forming a large, meaningful group Signup and view all the answers

Study Notes

Investors evaluate expected returns using three methods: peer group comparisons, index returns, and risk factor models
Performance assessment involves answering two questions: how did the portfolio manager perform, and what resources were used to achieve it
Peer group comparisons use boxplots to display returns of a representative set of investors over a specific period, but they have limitations such as lack of adjustment for risk levels and difficulty in forming a large, meaningful group
Portfolio drawdown measures how well the manager protected investors against losses, with maximum drawdown being the largest percentage decline in value from peak to trough
Risk-adjusted performance measures include Sharpe Ratio, Treynor Ratio, and Information Ratio, which aim to measure a portfolio's total risk and performance relative to a benchmark
Sharpe Ratio measures risk premium per unit of risk by subtracting the risk-free rate from the portfolio's return and dividing by the standard deviation of returns
Treynor Ratio measures the portfolio's return in excess of the risk-free rate per unit of beta, indicating the slope of the fund's characteristic line and its position relative to the security market line
Information Ratio measures a portfolio's average return in excess of a benchmark portfolio divided by the tracking error
Jensen Measure, originally based on CAPM, calculates the difference between a portfolio's return and the return expected based on market conditions, with α indicating the manager's superiority or inferiority in investment ability.
Risk-adjusted performance can be computed relative to any multifactor model, with attribution analysis decomposing the difference between a manager's total return and a benchmark policy portfolio into allocation and selection effects.

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Description

Test your understanding of performance management, risk-adjusted measures, attribution analysis, and desirable attributes of a fund manager. Calculate and interpret risk-adjusted performance measures and compare simple and risk-adjusted measures.