CHAPTER 18—EVALUATION OF PORTFOLIO PERFORMANCE
TRUE/FALSE
1. Investors want their portfolio managers to completely diversify their portfolio, that is, eliminate all
systematic risk.
2. A peer group comparison collects the returns produced by a representative universe of investors over a
specific period of time and displays them in a simple boxplot format.
3. The typical proxy for the market portfolio is the S&P/TSX Composite Index because it is diversified
and price weighted.
4. Treynor’s performance measure implicitly assumes a completely diversified portfolio.
5. A negative Treynor measure (negative T) for a portfolio always indicates that the portfolio would plot
below the SML.
6. Sharpe’s performance assumes that all portfolios are completely diversified.
7. The Sharpe measure examines the risk premium per unit of systematic risk.
8. The Sharpe and Treynor measures complement each other and thus both should be used to measure
portfolio performance.
9. The Sharpe and Treynor measures always give different rankings.
10. Overall performance is the total return above the risk free rate.
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11. The Jensen measure requires that each period’s rates of return and risk-free rate be measured, rather
than using the long-term averages as in the Treynor and Sharpe measures.
12. The ranking differences between the Sharpe, Treynor and Jensen performance measures occur because
of the differences in diversification.
13. Funds with low levels of diversification tend to “beat the market.”
14. The portfolio performance measure that can be most affected by a benchmark error is the Sharpe
measure.
15. Attribution analysis separates a portfolio manager’s performance into an allocation effect and selection
effect.
16. An appropriate composite risk measure that indicates the relative price volatility for a bond compared
to interest rate changes is the bond’s yield to maturity.
17. In evaluating bond performance, the Russell 3000 Index is an appropriate risk measure.
18. The policy effect is a difference in bond portfolio performance from that of a benchmark index due to
a difference in duration.
19. Duration is considered a good measure of risk for a bond portfolio because it indicates the relative
volatility of the bond or portfolio due to interest rate changes and also the rating of the bonds.
20. A test of bond performance over time indicated that bond portfolio managers are more consistent over
time than equity managers.
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21. A portfolio manager should be evaluated many times and in a variety of market environments before a
final judgment is reached regarding his/her strengths and weaknesses.
22. Two desirable attributes of a portfolio manager’s performance are the ability to derive above-average
returns for a given risk class and the ability to time the market.
23. The most common manner of evaluating portfolio managers is a peer group comparison.
24. Treynor developed the first composite measure of portfolio performance by introducing the capital
market line, which defines the relationship between the return of a portfolio over time and the return
for the market portfolio.
25. The Sharpe measure of portfolio performance divides the portfolio’s risk premium by the portfolio’s
beta.
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MULTIPLE CHOICE
1. The major requirements of a portfolio manager include the following, except
a.
Follow the client’s policy statement.
b.
Completely diversify the portfolio to eliminate all unsystematic risk..
c.
The ability to derive above-average risk adjusted returns.
d.
Completely diversify the portfolio to eliminate all systematic risk.
e.
None of the above (that is, all are requirements of a portfolio manager)
2. Portfolio managers who anticipate an increase in interest rates should
a.
Act to keep the duration constant.
b.
Decrease the portfolio duration.
c.
Increase the portfolio duration.
d.
Assume higher risk in the market.
e.
Invest in junk bonds.
3. Treynor showed that rational, risk averse investors always prefer portfolio possibility lines that have
a.
Zero slopes.
b.
Slightly negative slopes.
c.
Highly negative slopes.
d.
Slightly positive slopes.
e.
Highly positive slopes.
4. The measure of performance which divides the portfolio’s risk premium by the portfolio’s beta is the
a.
Sharpe measure.
b.
Jensen measure.
c.
Fama measure.
d.
Information Ratio.
e.
Treynor measure.
5. Sharpe’s performance measure divides the portfolio’s risk premium by the
a.
Standard deviation of the rate of return.
b.
Variance of the rate of return.
c.
Slope of the fund’s characteristic line.
d.
Beta.
e.
Risk free rate.
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6. Which measure of portfolio performance allows analysts to determine the statistical significance of
abnormal returns?
a.
Sharpe measure
b.
Jensen measure
c.
Fama measure
d.
Information Ratio
e.
Treynor measure
7. Selectivity measures how well a portfolio performed relative to a
a.
Market portfolio (S&P 400).
b.
Portfolio of the same securities in the previous period.
c.
Naively selected portfolio of equal risk.
d.
Naively selected portfolio of equal return.
e.
World market portfolio.
8. A portfolio performance measurement technique that decomposes the return of a manager’s holdings to
a predetermined benchmark’s returns and separates the difference into an allocation and selection is
called
a.
Immunization analysis.
b.
Performance attribution analysis.
c.
Tactical rankings.
d.
Convexity utilization.
e.
Duration matching attrition.
9. Under the performance attribution analysis method, the ______ measures the manager’s decision to
over- or underweight a particular market segment in terms of that segment’s return performance
relative to the overall return to the benchmark.
a.
Selection effect
b.
Allocation effect
c.
Distribution effect
d.
Diversification effect
e.
Attribution effect
10. Under the performance attribution analysis method, the ____ measures the manager’s ability to form
specific market segment portfolios that generate superior returns relative to the way in which the
comparable market segment is defined in the benchmark portfolio weighted by the manager’s actual
market segment investment proportions.
a.
Selection effect
b.
Allocation effect
c.
Distribution effect
d.
Diversification effect
e.
Attribution effect
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11. If the return increases as more global investments with low correlation are added to the market
portfolio, the efficient frontier moves
a.
Up and right.
b.
Up and left.
c.
Down and right.
d.
Down and left.
e.
Up only.
12. Information ratio portfolio performance measures
a.
Adjust portfolio risk to match benchmark risk.
b.
Compare portfolio returns to expected returns under CAPM.
c.
Evaluate portfolio performance on the basis of return per unit of risk.
d.
Indicate historic average differential return per unit of historic variability of differential
return.
e.
None of the above.
13. Relative return portfolio performance measures
a.
Adjust portfolio risk to match benchmark risk.
b.
Compare portfolio returns to expected returns under CAPM.
c.
Evaluate portfolio performance on the basis of return per unit of risk.
d.
Indicate historic average differential return per unit of historic variability of differential
return.
e.
None of the above.
14. Excess return portfolio performance measures
a.
Adjust portfolio risk to match benchmark risk.
b.
Compare portfolio returns to expected returns under CAPM.
c.
Evaluate portfolio performance on the basis of return per unit of risk.
d.
Indicate historic average differential return per unit of historic variability of differential
return.
e.
None of the above.
15. For a poorly diversified portfolio the appropriate measure of portfolio performance would be
a.
The Treynor measure because it evaluates portfolio performance on the basis of return and
diversification.
b.
The Sharpe measure because it evaluates portfolio performance on the basis of return and
diversification.
c.
The Treynor measure because it uses standard deviation as the risk measure.
d.
The Sharpe measure because it uses beta as the risk measure.
e.
None of the above.
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16. Components of overall portfolio performance include
a.
Selectivity.
b.
Manager’s risk.
c.
Security risk.
d.
Choices a and b.
e.
Choices a, b, and c.
17. A portfolio’s gross selectivity is made up of
a.
Manager’s risk.
b.
Net selectivity.
c.
Diversification.
d.
Choices a and b.
e.
Choices b and c.
18. Bailey, Richards, and Tierney maintain that any useful benchmark should have the following
characteristics.
a.
Measurable.
b.
Investable.
c.
Value-weighted.
d.
Choices a and b.
e.
Choices a, b, and c.
19. Which of the following statements concerning performance measures is false?
a.
The Sharpe measure examines both unsystematic and systematic risk.
b.
The Treynor measure examines systematic risk.
c.
The Jensen measure examines systematic risk.
d.
All three measures examine both unsystematic and systematic risk.
e.
None of the above (that is, all statements are true)
20. Which of the following statements about returns-based analysis or effective mix analysis is true?
a.
This analysis compares the historical return pattern of the portfolio in question with the
historical returns of various well-specified indexes.
b.
This analysis uses sophisticated quadratic programming techniques to indicate what styles
or style combinations were most similar to the portfolio’s actual historical returns.
c.
This analysis is based on the belief that the portfolio’s current make-up will be a good
predictor for the next period’s returns.
d.
Choices a and b
e.
All of the above statements describe returns-based analysis or effective mix analysis
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21. A manager’s superior returns could have occurred due to:
a.
an insightful asset allocation strategy, over weighting an asset class that earned high
returns.
b.
investing in undervalued sectors.
c.
selecting individual securities that earned above average returns.
d.
Choices a and c.
e.
All of the above.
22. In the evaluation of bond portfolio performance, the policy effect refers to
a.
The difference in portfolio duration and index duration.
b.
The extra return attributable to acquiring bonds that are temporarily mispriced relative to
risk.
c.
To short-run changes in the portfolio during a specific period.
d.
The differential return from changing duration of the portfolio during a specific period.
e.
None of the above.
23. In the evaluation of bond portfolio performance, the interest rate anticipation effect refers to
a.
The difference in portfolio duration and index duration.
b.
The extra return attributable to acquiring bonds that are temporarily mispriced relative to
risk.
c.
To short-run changes in the portfolio during a specific period.
d.
The differential return from changing duration of the portfolio during a specific period.
e.
None of the above
24. In the evaluation of bond portfolio performance, the analysis effect refers to
a.
The difference in portfolio duration and index duration.
b.
The extra return attributable to acquiring bonds that are temporarily mispriced relative to
risk.
c.
To short-run changes in the portfolio during a specific period.
d.
The differential return from changing duration of the portfolio during a specific period.
e.
None of the above
25. In the Characteristic Selectivity (CS) performance measure,
a.
Portfolio performance is measured by assessing the quality of services provided by money
managers by looking at adjustments made to the content of their portfolios.
b.
Portfolio performance is measured by examining both unsystematic and systematic risk.
c.
Portfolio performance is measured by comparing the returns of each stock in the portfolio
to the return of a benchmark portfolio. With the same aggregate investment characteristics
as the security in question.
d.
Portfolio performance is measured on the basis of return per unit of risk.
e.
Portfolio performance is measured on the basis of historic average differential return per
unit of historic variability of differential return.
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26. A more recent adjustment to the Sharpe measurement for portfolio evaluation is
a.
To divide the portfolio risk premium by total risk rather than the portfolio’s beta.
b.
To divide the portfolio risk premium by standard deviation rather than the portfolio’s beta.
c.
To divide the portfolio risk premium by the excess portfolio return rather than total risk.
d.
To divide the excess portfolio return by the portfolio’s standard deviation.
e.
To divide the excess portfolio return by the portfolio’s beta.
27. Which portfolio measurement uses the mean excess return in the numerator divided by the amount of
residual risk that the investor incurred in pursuit of those excess returns?
a.
Jensen measure.
b.
Fama measure.
c.
Sharpe measure.
d.
Treynor ratio.
e.
Information ratio.
28. The cost of active management is the coefficient ER and it is sometimes referred to as
a.
Market timing.
b.
Reward for risk.
c.
Excess reward.
d.
Excess risk.
e.
Tracking error.
29. A disadvantage of the Treynor and Sharpe measures is that
a.
They produce absolute performance rankings.
b.
The beta and standard deviation are static.
c.
They are both difficult to compute.
d.
They produce relative performance rankings.
e.
They give very different measurements for well-diversified portfolios.
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Exhibit 18-1
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The portfolios identified below are being considered for investment. During the period under
consideration Rf = .03.
Portfolio
Return
Beta
A
0.16
1.0
0.15
B
0.22
1.5
0.10
C
0.11
0.6
0.08
D
0.18
1.1
0.12
30. Refer to Exhibit 18-1. Using the Sharpe Measure, which portfolio performed best?
a.
A
b.
B
c.
C
d.
D
e.
Two portfolios are tied
31. Refer to Exhibit 18-1. According to the Treynor Measure, which portfolio performed best?
a.
A
b.
B
c.
C
d.
D
e.
Two portfolios are tied
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Exhibit 18-2
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The portfolios identified below are being considered for investment. Assume that during the period
under consideration Rf = .04.
Portfolio
Return
Beta
W
0.18
1.8
0.06
X
0.21
0.9
0.10
Y
0.13
0.7
0.03
Z
0.16
1.5
0.07
32. Refer to Exhibit 18-2. Using the Sharpe Measure, which portfolio performed best?
a.
W
b.
X
c.
Y
d.
Z
e.
Two portfolios are tied
33. Refer to Exhibit 18-2. According to the Treynor Measure, which portfolio performed best?
a.
W
b.
X
c.
Y
d.
Z
e.
Two portfolios are tied
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Exhibit 18-3
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider the data presented below on three mutual funds and the market.
Standard
Fund
Beta
Deviation (%)
Return (%)
Rf (%)
AAA
0.75
7.0
14
3
BBB
1.05
5.0
18
3
CCC
0.89
8.0
20
3
Market
1.00
8.0
12
3
34. Refer to Exhibit 18-3. Compute the Sharpe Measure for the AAA fund.
a.
4.49
b.
2.74
c.
1.57
d.
1.70
e.
1.27
35. Refer to Exhibit 18-3. Compute the Jensen Measure for the BBB fund.
a.
4.49
b.
2.74
c.
4.25
d.
5.55
e.
8.99
36. Refer to Exhibit 18-3. Compute the Treynor Measure for the CCC fund.
a.
14.7
b.
15.3
c.
19.1
d.
17.0
e.
12.7