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Question

Sharp ratio

Answer 1

William Sharpe US Economist Measure the return of an investment whilst adjusting for its risk. Measures excess return for every unit of risk taken. Return on investment- risk free return ÷ standard deviation of the return Normally measured in months but can annualise by x the average monthly return by 12 and square rooting by 12 the standard deviation. The higher the Sharpe, the better the return compensates the investor for the risk taken. Negative indicates a risk free asset would have performed better than the one being analysed. Can be useful to see whether the returns are due to skilful investment management or result of excessive risk.

Answer 2

Jensen's alpha. The difference between the return you would expect from a security, given its beta, and the actual return produced. It is seen as a measure of the value added by the investment manager. It is a return that is not explained by CAPM. a = actual portfolio return - (risk-free return + beta (market return - risk-free)) a = Rp - (Rf +Bi (Rm - Rf)) I made Rp up it's actually written out in full 'as actual portfolio return in the book!

Answer 3

Used to assess the risk-adjust3d performance of active portfolio managers. Guage their skill. Measures the relative return, which is the difference between the return on the activity managed portfolio and its benchmark. = Rp - Rb ÷ tracking error Rp = Portfolio return Rb = Benchmark return The higher the information ratio, the more value added by the manager. A negative information ratio would mean an investor would probably have achieved better returns using a tracker or index fund.

Answer 4

The market has a beta of 1. The beta of a security reflects the extent to which the security's return moves up and down with the market. More than 1 = exaggerated movement. More volatile. Leas than 1 = less movement, more stable. CAPM provides the relationship between a security's systematic risk and it's expected return. So those with a high beta can be expected to produce high returns in a rising market.

Answer 5

CAPM provides the relationship between a security's systematic risk and its expected return. So, those with a high beta can be expected to produce high returns in a rising market. Based on assumptions: 1. Investors are rational and risk-averse. 2. All investors have an identical holding period. 3. The market has many buyers and sellers, and no one individual can affect the market price. 4. There are no taxes, transaction costs & no restorations on short-selling. 5. Information is free and available to investors. 6. All investors can borrow and lend unlimited amounts of money at the risk-free rate. 7. The quantity of risky securities in the market is fixed & all are fully marketable (I.e. the liquidity of an asset is ignored).

Answer 6

1. What to use as the risk-free free rate? Common practise is UK Gov treasury bills. 2. What is the market portfolio? In theory, it should be all risky securities worldwide, but in reality, an index of national shares is normally used, e.g., FTSE all share or FTSE 100. Different indices have significantly different betas. So if the true market portfolio is not used m, can the correct beta be determined? 3. The suitability of beta For CAPM to be useful, beta must be stable and predictable, but past experience shows this not to be true. So, if unstable, how can it be reliable in predicting future risk? Also, CAPM suggests a direct relationship between excess returns over risk-free returns and its beta. However, studies in the US have not found this relationship.

Answer 7

91 day money market instruments issues by the Gov. Virtually no default risk. Their short life also means interest rate risk and inflation risk are minimised. No coupon.

Answer 8

Hedge funds - Up front 1% - 2% AMC - 2% & 20% performance fees. Unit linked funds - 5% bid offer spread. AMC 0.75% - 1% Passive funds- 0.1% - 0.75% Active funds - 0.75% - 1.75% Bond funds - 1% AMC

Answer 9

Traded at their nominal/par/face value. Price is quoted for a standard £100 nominal value. Prices quoted in FT & other major newspapers but not the price the investor would pay because.... 1. They are mid market prices between the bid and offer prices quoted. 2. They are clean prices. Price of the stock, not including the interest that accrues daily. Once interest taken into account = dirty price.

Answer 10

Usually paid 6 monthly but accrued daily. The interest is paid to whoever is the registered holder of the bond 7 days before the payment date. Cum dividend - the purchase receives the full 6 months interest even though they are not entitled to it and so will pay more (clean price + accrued interest). Ex dividend - If sold in the 7 day window. Dividends will go to the seller and so buyer loses out on the interest on the days from when they bought to the payment date so price is adjusted to reflect (clean price - loss interest). The adjusted price, whether more or less than the clean price, is called the dirty price.

Answer 11

Professor Harry Markowitz 1952. Reflects the way portfolios can be constructed to maximise returns and minimise risks. Assumes, like CAPM, that investors are risk averse & would choose less risk for the same return. Harry demonstrated that portfolio diversification could reduce risk and increase returns. Conclusion - a diversified portfolio of imperfectly correlated asset classes can provide high returns with least amount of volatility.

Answer 12

Most commonly used measure of risk. Measures how widely the actual return varies to its average or expected return. As a rule of thumb, return can be expected to fall within one standard deviation of the average return roughly 68% of the time. Within 2 standard deviations 95% of the time. If SD is 5% and the average return is 10%... 68% of the time it will fall between 5% - 15% 95% of the time it will fall between 0% & 20%.

Answer 13

Ability of a company to continue to pay its dividend. Dividend cover looks at how many times a company could have paid its dividend based on the profit for the year. = EPS ÷ Dividend per share

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