Investment Ratios & Portfolio Management PDF

Describe in detail the following ratios, how they are calculated and explain what they are used for. Contrast the ratios in terms of usefulness. Sharpe ratio Treynor ratio Jensen measure Information ratio Sharpe ratio is used to assess the performance of an investment by adjusting for its risks...

Describe in detail the following ratios, how they are calculated and explain what they are used for. Contrast the ratios in terms of usefulness. Sharpe ratio Treynor ratio Jensen measure Information ratio Sharpe ratio is used to assess the performance of an investment by adjusting for its risks. The higher the ratio, the higher the investment return relative to the amount of risk. A higher Sharpe ratio indicates that the portfolio is providing better returns for each unit of total risks. if the answer is \< 1 it is viewed as bad. If the answer is between 1 and 1.99: viewed as adequate 2 -- 2.99; very good Greater than 3 is seen as Excellent. Advantages and Disadvantages of Sharpe Ratio \| eFM Treynor's ratio measures risk-adjusted return. It considers only systematic risks which is represented by beta. Sharpe uses total risk which is both systematic and unsystematic. A higher Treynor ratio means better performance relative to systematic risk. The Treynor ratio is useful for evaluating the performance of a portfolio that is well-diversified, as it focuses on systematic risk. Treynor Ratio \| Meaning, Formula, Example, Importance, Pros-Cons, \| eFM Jensen's Alpha measures the excess return of a portfolio over what would be expected based on its beta and the market return. A positive alpha indicates that the portfolio has outperformed the market, after adjusting for its risk, while a negative alpha suggests underperformance. This measure is useful when assessing actively managed funds or portfolios Jensen\'s Alpha Formula: Measure and \... The Information Ratio measures the risk-adjusted return relative to a benchmark, accounting for the consistency of that performance (tracking error). A higher Information Ratio indicates that the portfolio is delivering consistent excess returns over the benchmark, relative to the volatility of those excess returns. This ratio is highly useful for evaluating the performance of active fund managers relative to a benchmark. It focuses on the consistency of excess returns, rather than just the magnitude of returns, which makes it particularly relevant for comparing managers who aim to outperform a benchmark with less volatility. You are about to launch a new fund and as such outline the portfolio management process. (20 marks) Policy statement Objectives Asset allocation/investment strategy / diversification Risk Control Portfolio rebalancing. Briefly describe modern portfolio theory and what are the underlying\ assumptions? Also, include the key MPT graph and explain each element\ on the graph? (25 marks) The modern Portfolio Theory assumes that investors make rational decisions when they possess sufficient information. One of the theory's assumptions is that investors enter the market to maximise their returns while at the same time avoiding unnecessary\ risk. MPT emphasizes that by diversifying investments across various asset classes, investors can reduce the overall risk of the portfolio without sacrificing expected returns. The key idea is that different assets do not always move in the same direction, and combining assets that are not perfectly correlated can reduce portfolio volatility.  2\. Briefly describe 5 common behavioural finance biases. (10 marks). C O O H E **Endowment Effect** - **Description:**\ People place a higher value on assets they already own compared to similar assets they don't own. - **Example:**\ Refusing to sell a stock because of sentimental attachment, even when there are better investment opportunities. **Herding Bias** - **Description:**\ People tend to follow the crowd, making decisions based on what others are doing rather than independent analysis. **Confirmation Bias** - **Description:**\ Investors seek out or give more weight to information that confirms their existing beliefs and ignore evidence that contradicts them. This leads to biased decision-making and poor investment choices. - **Description:**\ Investors overestimate their knowledge, abilities, or the accuracy of their predictions. They may trade excessively or take on too much risk, believing they have better insights than they actually do. \] Optimism bias -- A tendency to wishful thinking and over-confidence in our plans.