CFM Valuation & Performance Measurement Flashcards

What does the Sharpe ratio measure in fund performance evaluation?

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

The Sharpe ratio divides a portfolio's excess return over the risk-free rate by its standard deviation, measuring return per unit of total risk.

What is the information ratio (IR) used to assess?

Answer: Active return relative to benchmark per unit of tracking error

The IR measures a manager's ability to generate excess returns relative to a benchmark, divided by the variability of those excess returns (tracking error).

What does time-weighted rate of return (TWRR) eliminate from performance measurement?

Answer: The distorting effect of investor cash flows on portfolio returns

TWRR breaks the measurement period into sub-periods at each cash flow event, preventing external cash flows from distorting the manager's actual investment performance.

In the context of CAPM, what does alpha represent?

Answer: The return generated in excess of what CAPM predicts given the portfolio's beta

Alpha (Jensen's alpha) is the intercept of the security characteristic line and represents value added by the manager beyond market-driven returns.

How does the Sortino ratio differ from the Sharpe ratio?

Answer: The Sortino ratio uses downside deviation instead of total standard deviation

The Sortino ratio only penalizes harmful downside volatility, making it more relevant for investors who are unconcerned about upside price variation.

What is maximum drawdown as a performance metric?

Answer: The largest peak-to-trough decline in portfolio value over a specified period

Maximum drawdown measures the worst cumulative loss from a portfolio peak to a subsequent trough, quantifying downside risk for investors.