Chapter 18 - Portfolio Performance Evaluation

Chapter 18 - Portfolio Performance Evaluation
Chapter 18
Portfolio Performance Evaluation

Multiple Choice Questions

1. A mutual fund with a beta of 1.1 has outperformed the S&P500 over the last 20 years. We
know that this mutual fund manager _______________________.
A. must have had superior stock selection ability
B. must have had superior asset allocation ability
C. must have had superior timing ability
D. may or may not have outperformed the S&P500 on a risk adjusted basis
2. The comparison universe is __________.

A. the bogey portfolio
B. a set of mutual funds with similar risk characteristics to your mutual fund
C. the set of all mutual funds in the U.S.A.
D. the set of all mutual funds in the world
3. Which one of the following performance measures is the Sharpe measure?

A. Average excess return to beta ratio
B. Average excess return to standard deviation ratio
C. Alpha to standard deviation of residuals ratio
D. Average return minus required return
4. The M2 measure is a variant of ________________.

A. the Sharpe measure
B. the Treynor measure
C. Jensen's alpha
D. the appraisal ratio
18-1
5. A managed portfolio has a standard deviation equal to 22% and a beta of 0.9 when the
market portfolio's standard deviation is 26%. The adjusted portfolio P* needed to calculate the
M2 measure will have ________ invested in the managed portfolio and the rest in T-bills.
A. 84.6%
B. 118%
C. 18%
D. 15.4%
6. Your return will generally be higher using the __________ if you time your transactions
poorly and your return will generally be higher using the __________ if you time your
transactions well.
A. dollar-weighted return method; dollar-weighted return method
B. dollar-weighted return method; time-weighted return method
C. time-weighted return method; dollar-weighted return method
D. time-weighted return method; time-weighted return method
7. Consider the Sharpe and Treynor performance measures. When a pension fund is large and
well diversified in total and it has many managers, the __________ measure is better for
evaluating individual managers while the __________ measure is better for evaluating the
manager of a small fund with only one manager responsible for all investments that may not
be fully diversified.
A. Sharpe; Sharpe
B. Sharpe; Treynor
C. Treynor; Sharpe
D. Treynor; Treynor
8. Henriksson found that, on average, betas of funds __________ during market advances.
A. decreased slightly
B. decreased very significantly
C. increased slightly
D. increased very significantly
18-2
9. Suppose that over the same time period two portfolios have the same average return and the
same standard deviation of return, but portfolio A has a higher beta than portfolio B.
According to the Sharpe measure, the performance of portfolio A __________.
A. is better than the performance of portfolio B
B. is the same as the performance of portfolio B
C. is poorer than the performance of portfolio B
D. cannot be measured since there is no data on the alpha of the portfolio
10. Most professionally managed equity funds __________.

A. outperform the S&P 500 index on both raw and risk-adjusted return measures
B. outperform the S&P 500 index on raw return measures and underperform the S&P 500
index on risk-adjusted return measures
C. underperform the S&P 500 index on both raw and risk-adjusted return measures
D. underperform the S&P 500 index on raw return measures and outperform the S&P 500
The risk free rate, average returns, standard deviations and betas for three funds and the
S&P500 are given below.

11. What is the T2 measure for portfolio A?

A. 12.4%
B. 2.38%
C. 0.91%
D. 3.64%
18-3
12. What is the M2 measure for portfolio B?

A. 0.43%
B. 1.25%
C. 1.77%
D. 1.43%
13. If these portfolios are subcomponents which make up part of a well diversified portfolio
then portfolio ______ is preferred.
A. A
B. B
C. C
D. S&P500
14. Based on the M2 measure, portfolio C has a superior return of _____ as compared to the
S&P500.
A. -1.33%
B. 1.43%
C. 2.00%
D. 0.00%
15. Which one of the following is largely based on forecasts of macroeconomic factors?

A. Security selection
B. Passive investing
C. Market efficiency
D. Market timing
16. Based on the example used in the book, a perfect market timer would have made _______
of dollars on a $1 investment between 1926 and 2008.
A. $100
B. $1,626
C. $1.5 million
D. $36.7 billion
18-4
The average returns, standard deviations and betas for three funds are given below along with
data for the S&P 500 index. The risk free return during the sample period is 6%.

17. You wish to evaluate the three mutual funds using the Sharpe measure for performance
evaluation. The fund with the highest Sharpe measure of performance is __________.
A. Fund A
B. Fund B
C. Fund C
D. indeterminable
18. You wish to evaluate the three mutual funds using the Treynor measure for performance
evaluation. The fund with the highest Treynor measure of performance is __________.
A. Fund A
B. Fund B
C. Fund C
D. indeterminable
19. You wish to evaluate the three mutual funds using the Jensen measure for performance
evaluation. The fund with the highest Jensen measure of performance is __________.
A. Fund A
B. Fund B
C. Fund C
D. S&P500
18-5
In a particular year, Salmon Arm Mutual Fund earned a return of 16% by making the
following investments in asset classes:

The return on a bogey portfolio was 12% calculated as follows:

20. The total excess return on the managed portfolio was __________.

A. 2%
B. 3%
C. 4%
D. 5%
21. The contribution of asset allocation across markets to the total excess return was
__________.
A. 1.5%
B. 2.0%
C. 2.5%
D. 3.5%
22. The contribution of security selection within asset classes to the total excess return was
__________.
A. 1.5%
B. 2.0%
C. 2.5%
D. 3.5%
18-6
In a particular year, Lost Hope Mutual Fund made the following investments in asset classes:

23. The total extra return on the managed portfolio was __________.

A. 1%
B. 2%
C. 3%
D. 4%
24. The contribution of asset allocation across markets to the total extra return was
__________.
A. -1%
B. 0%
C. 1%
D. 2%
25. The contribution of security selection within asset classes to the total extra return was
__________.
A. -1%
B. 0%
C. 1%
D. 2%
18-7
26. Which one of the following averaging methods is the preferred method of constructing
returns series for use in evaluating portfolio performance?
A. Geometric average
B. Arithmetic average
C. Dollar-weighted
D. Internal
27. The __________ calculates the reward to risk trade-off by dividing the average portfolio
excess return by the portfolio beta.
A. Sharpe measure
B. Treynor measure
C. Jensen measure
D. appraisal ratio
28. In creating the T2 measure one mixes P* and T-bills to match the _____ of the market and
in creating the M2 measure one mixes P* and T-bills to match the _____ of the market.
A. alpha; beta
B. beta; alpha
C. beta; standard deviation
D. standard deviation; beta
29. The M2 measure of portfolio performance was developed by ______________.

A. Modigliani and Treynor
B. Modigliani and Modigliani
C. Merton and Miller
D. Fama and French
30. Probably the biggest problem with evaluating portfolio performance of actively managed
funds is the assumption that __________________________.
A. the markets are efficient
B. portfolio risk is constant over time
C. diversification pays off
D. security selection is more valuable than asset allocation
18-8
31. Perfect timing ability is equivalent to having __________ on the market portfolio.

A. a call option
B. a futures contract
C. a put option
D. a forward contract
32. One hundred fund managers enter a contest to see how many times in thirteen years they
can earn a higher return than their competitors. The probability distribution of the number of
successful years out of thirteen for the best performing money managers is

Out of this sample, chance alone would indicate that there is a ______ probability that
someone would beat the market at least 11 times out of 13 years.
A. 51.3%
B. 65.9%
C. 67.1%
D. 10.83%
33. The Treynor-Black model is a model that shows how an investment manager can use
security analysis and statistics to construct __________.
A. a market portfolio
B. a passive portfolio
C. an active portfolio
D. an index portfolio
18-9
34. If an investor is a successful market timer, his distribution of monthly portfolio returns
will __________.
A. be skewed to the left
B. be skewed to the right
C. exhibit kurtosis
D. exhibit neither skewness nor kurtosis
35. Recent analysis indicates that the style of investing is a critical component of fund
performance. In fact on average about _____ of fund performance is attributable to the asset
allocation decision.
A. 68%
B. 74%
C. 88%
D. 97%
36. In the Treynor-Black model, the active portfolio will contain stocks with __________.
A. alphas equal to zero
B. negative alphas
C. positive alphas
D. some negative and some positive alphas
37. Portfolio performance is often decomposed into various subcomponents such as the return
due to ___________.
I. broad asset allocation across security classes
II. sector weightings within equity markets
III. security selection with a given sector
The one decision that contributes most to the fund performance is
A. I
B. II
C. III
D. All contribute equally to fund performance
18-10
38. The theory of efficient frontiers has __________.

A. no adherents among practitioners
B. a small number of adherents among practitioners
C. a significant number of adherents among practitioners
D. complete support by practitioners
39. In the Treynor-Black model security analysts __________.

A. analyze a relatively small number of stocks
B. analyze all stocks which are publicly traded
C. are redundant
D. devote their attention to market timing rather than fundamental analysis

A. analyze the entire universe of stocks
B. assume that markets are inefficient
C. treat market index as a baseline portfolio upon which an active portfolio is constructed
D. focus on selecting the best performing bogey
41. Active portfolio management consists of __________.

I. market timing
II. security selection
III. sector selection within given markets
IV. indexing
A. I and II only
B. II and III only
C. I, II and III only
D. I, II, III and IV
42. A market timing strategy is one where asset allocation in the stock market __________
when one forecasts the stock market will outperform treasury bills.
A. decreases
B. increases
C. remains the same
D. may increase or decrease
18-11
43. In the Treynor-Black model, the contribution of individual security to the active portfolio
should be based primarily on the stock's _________.
A. alpha
B. beta
C. the residual variance
D. appraisal ratio
44. If all ___ are ___ in the Treynor-Black model, there would be no reason to depart from the
passive portfolio.
A. alphas; zero
B. alphas; positive
C. betas; positive
D. standard deviations; positive
45. In the Treynor-Black model, the weight of each analyzed security in the portfolio should
be proportional to its __________.
A. alpha/beta
B. alpha/residual variance
C. beta/residual variance
D. none of the above
46. The critical variable in the determination of the success of the active portfolio is the
stock's __________.
A. alpha/nonsystematic risk
B. alpha/systematic risk
C. delta/nonsystematic risk
D. delta/systematic risk
18-12
47. Consider the theory of active portfolio management. Stocks A and B have the same
positive alpha and the same nonsystematic risk. Stock A has a higher beta than stock B. You
should want __________ in your active portfolio.
A. equal proportions of stocks A and B
B. more of stock A than stock B
C. more of stock B than stock A
D. more information is needed to answer this question
48. Consider the theory of active portfolio management. Stocks A and B have the same beta
and non-systematic risk. Stock A has higher positive alpha than stock B. You should want
__________ in your active portfolio.
49. The market timing form of active portfolio management relies on __________ forecasting
and the security selection form of active portfolio management relies on __________
forecasting.
A. macroeconomic; macroeconomic
B. macroeconomic; microeconomic
C. microeconomic; macroeconomic
D. microeconomic; microeconomic
50. Active portfolio managers try to construct a risky portfolio with _______.

A. a higher Sharpe measure than a passive strategy
B. a lower Sharpe measure than a passive strategy
C. the same Sharpe measure as a passive strategy
D. very few securities
18-13
51. In performance measurement the bogey portfolio is designed to _________.

A. measure the returns to a completely passive strategy
B. measure the returns to a similar active strategy
C. measure the returns to a given investment style
D. equal the return on the S&P500
52. __________ portfolio manager(s) experience streaks of abnormal returns which are hard
to label as lucky outcomes, and ____ anomalies in realized returns have been sufficiently
persistent such that portfolio managers could use them to beat a passive strategy over
prolonged periods.
A. No; no
B. No; some
C. Some; no
D. Some; some
53. A passive benchmark portfolio is _______________.

I. a portfolio where the asset allocation across broad asset classes is neutral and not
determined by forecasts of performance of the different asset classes
II. one where an indexed portfolio is held within each asset class
III. often called the bogey
A. I only
B. I and III only
C. II and III only
D. I, II and III
54. The correct measure of timing ability is ____________ for a portfolio manager who
correctly forecasts 55% of bull markets and 55% of bear markets.
A. -5%
B. 5%
C. 10%
D. 95%
18-14
55. It is very hard to statistically verify abnormal fund performance because of all except
which one of the following?
A. Inevitably some fund managers experience streaks of good performance that may just be
due to luck
B. The noise in realized rates of return is so large as to make it hard to identify abnormal
performance in competitive markets
C. Portfolio composition is rarely stable long enough to identify abnormal performance
D. Even if successful, there is really not much value to be added by active strategies such as
market timing
56. Stocks A and B have alphas of .01 and betas of .90. Stock A has a residual variance of .
020 while stock B has a residual variance of .016. If stock A represents 2% of an active
portfolio, stock B should represent __________ of an active portfolio.
A. 1.6%
B. 2.0%
C. 2.2%
D. 2.5%
57. Portfolio managers Paul Martin and Kevin Krueger each manage $1,000,000 funds. Paul
Martin has perfect foresight and the call option value of his perfect foresight is $150,000.
Kevin Krueger is an imperfect forecaster and correctly predicts 50% of all bull markets and
70% of all bear markets. The correct measure of timing ability for Kevin Krueger is
__________.
A. 20%
B. 60%
C. 75%
D. 120%
18-15
70% of all bear markets. The value of Kevin Krueger's imperfect forecasting ability is
__________.
A. $30,000
B. $67,500
C. $108,750
D. $217,500
59. Chuck Douglass, an imperfect forecaster correctly predicts 57% of all bull markets and
68% of all bear markets. Roy Simmonds is a perfect forecaster. If Chuck Douglass is able to
charge a fee of $125,000, the fee that Roy Simmonds should charge is __________. Assume
that both forecasters manage similar size funds.
A. $31,250
B. $200,000
C. $500,000
D. $625,000
60. A mutual fund invests in large-capitalization stocks. Its performance should be measured
against which one of the following?
A. Russell 2000 index
B. S&P 500 index
C. Wilshire 5000 index
D. Dow Jones Industrial Average
61. Assume you purchased a rental property for $100,000 and sold it one year later for
$115,000 (there was no mortgage on the property). At the time of the sale, you paid $3,000 in
commissions and $1,000 in taxes. If you received $10,000 in rental income (all received at the
end of the year), what annual rate of return did you earn?
A. 6%
B. 11%
C. 20%
D. 25%
18-16
The table presents the actual return of each sector of the manager's portfolio in column (1),
the fraction of the portfolio allocated to each sector in column (2), the benchmark or neutral
sector allocations in column (3), and the returns of sector indexes in column 4.

62. What was the manager's return in the month?

A. 2.07%
B. 2.21%
C. 2.24%
D. 4.80%
63. What was the bogey's return in the month?

A. 2.07%
B. 2.21%
C. 2.24%
D. 4.80%
64. What was the manager's over or under performance for the month?
A. Under performance = 0.03%
B. Over performance = 0.03%
C. Over performance = 0.14%
D. Under performance = 3%
65. What is the contribution of security selection to relative performance?

A. -0.15%
B. 0.15%
C. -0.3%
D. 0.3%
18-17
66. What is the contribution of asset allocation to relative performance?

A. -0.18%
B. 0.18%
C. -0.15%
D. 0.15%
67. Morningstar's RAR produce results which are similar but not identical to ________.
A. Jensen's alpha
B. M2
C. the Treynor ratio
D. the Sharpe ratio
68. The Treynor-Black Model assumes security markets are _________.

A. completely efficient
B. nearly efficient
C. very inefficient
D. random walks
69. The appraisal ratio is equal to the stock's ____ divided by its ______.
A. diversifiable risk; beta
B. beta; alpha
C. alpha; beta
D. alpha; diversifiable risk
70. Empirical tests to date show ______________.

A. that many investors have earned large rewards by market timing
B. little evidence of market timing ability
C. clear cut evidence of substantial market timing ability
D. evidence that absolutely no market timing ability exists
18-18
71. A portfolio generates an annual return of 13%, a beta of 0.7 and a standard deviation of
17%. The market index return is 14% and has a standard deviation of 21%. What is the M2
measure of the portfolio if the risk free rate is 5%?
A. 0.58%
B. 0.68%
C. 0.78%
D. 0.88%
A. 2.15%
B. 2.76%
C. 2.94%
D. 3.14%
17%. The market index return is 14% and has a standard deviation of 21%. What is the
Treynor measure of the portfolio if the risk free rate is 5%?
A. .1143
B. .1233
C. .1354
D. .1477
A. .0833
B. .1083
C. .1114
D. .1163
18-19
Sharpe measure of the portfolio if the risk free rate is 5%?
A. .3978
B. .4158
C. .4563
D. .4706
A. .4757
B. .5263
C. .6842
D. .7252
17%. The market index return is 14% and has a standard deviation of 21%. What is Jensen's
alpha of the portfolio if the risk free rate is 5%?
A. .017
B. .034
C. .067
D. .078
A. .017
B. .028
C. .036
D. .078
18-20
79. The portfolio that contains the benchmark asset allocation against which a manager will
be measured is often called _____________.
B. the Vanguard Index
C. Jensen's alpha
D. the Treynor measure
80. An attribution analysis will NOT likely contain which of the following components?
A. Asset allocation
B. Index returns
C. Risk free returns
D. Security selection
81. Which of the following investment strategies would have produced the highest returns in
the time period since 1926?
A. T bills portfolio
B. S&P 500 index fund
C. Perfect market timing
D. Random stock selection
82. What phrase might be used as a substitute for the Treynor-Black model developed in
1973?
A. Solely active management
B. Enhanced index approach
C. Passive management
D. Random selection
83. What is the term for the process used to assess portfolio manager performance?
A. Active analysis
B. Attribution analysis
C. Passive analysis
D. Treynor Black Analysis
18-21
84. A fund has excess performance of 1.5%. In looking at the fund's investment breakdown
you see that the fund overweighed equities relative to the benchmark and the average return
on the fund's equity portfolio was slightly lower than the equity benchmark return. The excess
performance for this fund is probably due to _______________.
A. security selection ability
B. better sector weightings in the equity portfolio
C. the asset allocation decision
D. finding securities with positive alphas
85. For a market timer the _____________ will be higher when RM is higher.

A. portfolio's alpha and beta
B. portfolio's unsystematic risk
C. portfolio's beta and slope of the characteristic line
D. security selection component of the portfolio
86. The Treynor-Black model combines an actively managed portfolio with an efficiently

diversified portfolio in order to _______________________.
I. improve the diversification of the overall portfolio
II. improve the overall portfolio's Sharpe ratio
III. reach a higher CAL than otherwise would be possible
A. I only
B. I and II only
C. II and III only
D. I, II and III
and the same positive alpha. Stock A has higher nonsystematic risk than stock B. You should
want __________ in your active portfolio.
18-22
Chapter 18 Portfolio Performance Evaluation Answer Key

Multiple Choice Questions

1. A mutual fund with a beta of 1.1 has outperformed the S&P500 over the last 20 years. We
know that this mutual fund manager _______________________.
A. must have had superior stock selection ability
B. must have had superior asset allocation ability
C. must have had superior timing ability
D. may or may not have outperformed the S&P500 on a risk adjusted basis
Difficulty: Easy

2. The comparison universe is __________.

B. a set of mutual funds with similar risk characteristics to your mutual fund
C. the set of all mutual funds in the U.S.A.
D. the set of all mutual funds in the world
Difficulty: Easy

3. Which one of the following performance measures is the Sharpe measure?

A. Average excess return to beta ratio
B. Average excess return to standard deviation ratio
C. Alpha to standard deviation of residuals ratio
D. Average return minus required return
Difficulty: Easy

18-23
4. The M2 measure is a variant of ________________.

A. the Sharpe measure
B. the Treynor measure
C. Jensen's alpha
D. the appraisal ratio
Difficulty: Easy

5. A managed portfolio has a standard deviation equal to 22% and a beta of 0.9 when the
market portfolio's standard deviation is 26%. The adjusted portfolio P* needed to calculate the
M2 measure will have ________ invested in the managed portfolio and the rest in T-bills.
A. 84.6%
B. 118%
C. 18%
D. 15.4%
26/22 = 118%
Difficulty: Medium

6. Your return will generally be higher using the __________ if you time your transactions
poorly and your return will generally be higher using the __________ if you time your
transactions well.
A. dollar-weighted return method; dollar-weighted return method
B. dollar-weighted return method; time-weighted return method
C. time-weighted return method; dollar-weighted return method
D. time-weighted return method; time-weighted return method
Difficulty: Medium

18-24
7. Consider the Sharpe and Treynor performance measures. When a pension fund is large and
well diversified in total and it has many managers, the __________ measure is better for
evaluating individual managers while the __________ measure is better for evaluating the
manager of a small fund with only one manager responsible for all investments that may not
be fully diversified.
A. Sharpe; Sharpe
B. Sharpe; Treynor
C. Treynor; Sharpe
D. Treynor; Treynor
Difficulty: Medium

8. Henriksson found that, on average, betas of funds __________ during market advances.
A. decreased slightly
B. decreased very significantly
C. increased slightly
D. increased very significantly
Difficulty: Medium

9. Suppose that over the same time period two portfolios have the same average return and the
same standard deviation of return, but portfolio A has a higher beta than portfolio B.
According to the Sharpe measure, the performance of portfolio A __________.
A. is better than the performance of portfolio B
B. is the same as the performance of portfolio B
C. is poorer than the performance of portfolio B
D. cannot be measured since there is no data on the alpha of the portfolio
Difficulty: Medium

18-25
10. Most professionally managed equity funds __________.

A. outperform the S&P 500 index on both raw and risk-adjusted return measures
B. outperform the S&P 500 index on raw return measures and underperform the S&P 500
C. underperform the S&P 500 index on both raw and risk-adjusted return measures
D. underperform the S&P 500 index on raw return measures and outperform the S&P 500
Difficulty: Medium

The risk free rate, average returns, standard deviations and betas for three funds and the
S&P500 are given below.

11. What is the T2 measure for portfolio A?

A. 12.4%
B. 2.38%
C. 0.91%
D. 3.64%
Difficulty: Hard

18-26
12. What is the M2 measure for portfolio B?

A. 0.43%
B. 1.25%
C. 1.77%
D. 1.43%
Difficulty: Hard

13. If these portfolios are subcomponents which make up part of a well diversified portfolio
then portfolio ______ is preferred.
A. A
B. B
C. C
D. S&P500
Use the T2 method:

Portfolio B is preferred.
Difficulty: Hard

18-27
14. Based on the M2 measure, portfolio C has a superior return of _____ as compared to the
S&P500.
A. -1.33%
B. 1.43%
C. 2.00%
D. 0.00%
Difficulty: Hard

15. Which one of the following is largely based on forecasts of macroeconomic factors?

A. Security selection
B. Passive investing
C. Market efficiency
D. Market timing
Difficulty: Easy

16. Based on the example used in the book, a perfect market timer would have made _______
of dollars on a $1 investment between 1926 and 2008.
A. $100
B. $1,626
C. $1.5 million
D. $36.7 billion
Difficulty: Easy

18-28
The average returns, standard deviations and betas for three funds are given below along with
data for the S&P 500 index. The risk free return during the sample period is 6%.

17. You wish to evaluate the three mutual funds using the Sharpe measure for performance
evaluation. The fund with the highest Sharpe measure of performance is __________.
A. Fund A
B. Fund B
C. Fund C
D. indeterminable
Difficulty: Medium

18-29
18. You wish to evaluate the three mutual funds using the Treynor measure for performance
evaluation. The fund with the highest Treynor measure of performance is __________.
A. Fund A
B. Fund B
C. Fund C
D. indeterminable
Difficulty: Medium

19. You wish to evaluate the three mutual funds using the Jensen measure for performance
evaluation. The fund with the highest Jensen measure of performance is __________.
A. Fund A
B. Fund B
C. Fund C
D. S&P500
Difficulty: Medium

18-30
In a particular year, Salmon Arm Mutual Fund earned a return of 16% by making the
following investments in asset classes:

The return on a bogey portfolio was 12% calculated as follows:

20. The total excess return on the managed portfolio was __________.

A. 2%
B. 3%
C. 4%
D. 5%
Excess Return = .1600 - .1200 = .0400
Difficulty: Medium

21. The contribution of asset allocation across markets to the total excess return was
__________.
A. 1.5%
B. 2.0%
C. 2.5%
D. 3.5%
(.20 - .60)(.10 - .12) + (.80 - .40)(.1500 - .1200) = .0200
Difficulty: Hard

18-31
22. The contribution of security selection within asset classes to the total excess return was
__________.
A. 1.5%
B. 2.0%
C. 2.5%
D. 3.5%
(.12 - .10.20 + (.1700 - .1500).80 = .0200
Difficulty: Hard

In a particular year, Lost Hope Mutual Fund made the following investments in asset classes:

23. The total extra return on the managed portfolio was __________.

A. 1%
B. 2%
C. 3%
D. 4%
Excess Return = (0.8)(.09) + (0.2)(.04) - 0.07 = 0.01
Difficulty: Medium

18-32
24. The contribution of asset allocation across markets to the total extra return was
__________.
A. -1%
B. 0%
C. 1%
D. 2%
(.80 - .40)(.1 - .07) + (.20 - .60)(.05 - .07) = 0.02
Difficulty: Hard

25. The contribution of security selection within asset classes to the total extra return was
__________.
A. -1%
B. 0%
C. 1%
D. 2%
(.09 - .10)0.8 + (.04 - .05)0.2 = - 0.01
Difficulty: Hard

26. Which one of the following averaging methods is the preferred method of constructing
returns series for use in evaluating portfolio performance?
A. Geometric average
B. Arithmetic average
C. Dollar-weighted
D. Internal
Difficulty: Easy

18-33
27. The __________ calculates the reward to risk trade-off by dividing the average portfolio
excess return by the portfolio beta.
A. Sharpe measure
B. Treynor measure
C. Jensen measure
D. appraisal ratio
Difficulty: Easy

28. In creating the T2 measure one mixes P* and T-bills to match the _____ of the market and
in creating the M2 measure one mixes P* and T-bills to match the _____ of the market.
A. alpha; beta
B. beta; alpha
C. beta; standard deviation
D. standard deviation; beta
Difficulty: Medium

29. The M2 measure of portfolio performance was developed by ______________.

A. Modigliani and Treynor
B. Modigliani and Modigliani
C. Merton and Miller
D. Fama and French
Difficulty: Easy

30. Probably the biggest problem with evaluating portfolio performance of actively managed
funds is the assumption that __________________________.
A. the markets are efficient
B. portfolio risk is constant over time
C. diversification pays off
D. security selection is more valuable than asset allocation
Difficulty: Easy

18-34
31. Perfect timing ability is equivalent to having __________ on the market portfolio.

A. a call option
B. a futures contract
C. a put option
D. a forward contract
Difficulty: Easy

32. One hundred fund managers enter a contest to see how many times in thirteen years they
can earn a higher return than their competitors. The probability distribution of the number of
successful years out of thirteen for the best performing money managers is

Out of this sample, chance alone would indicate that there is a ______ probability that
someone would beat the market at least 11 times out of 13 years.
A. 51.3%
B. 65.9%
C. 67.1%
D. 10.83%
Probability = 51.3 + 14.6 + 1.2 = 67.1%
Difficulty: Hard

18-35
33. The Treynor-Black model is a model that shows how an investment manager can use
security analysis and statistics to construct __________.
A. a market portfolio
B. a passive portfolio
C. an active portfolio
D. an index portfolio
Difficulty: Easy

34. If an investor is a successful market timer, his distribution of monthly portfolio returns
will __________.
A. be skewed to the left
B. be skewed to the right
C. exhibit kurtosis
D. exhibit neither skewness nor kurtosis
Difficulty: Easy

35. Recent analysis indicates that the style of investing is a critical component of fund
performance. In fact on average about _____ of fund performance is attributable to the asset
allocation decision.
A. 68%
B. 74%
C. 88%
D. 97%
Difficulty: Medium

36. In the Treynor-Black model, the active portfolio will contain stocks with __________.
A. alphas equal to zero
B. negative alphas
C. positive alphas
D. some negative and some positive alphas
Difficulty: Easy

18-36
37. Portfolio performance is often decomposed into various subcomponents such as the return
due to ___________.
I. broad asset allocation across security classes
II. sector weightings within equity markets
III. security selection with a given sector
The one decision that contributes most to the fund performance is
A. I
B. II
C. III
D. All contribute equally to fund performance
Difficulty: Easy

38. The theory of efficient frontiers has __________.

A. no adherents among practitioners
B. a small number of adherents among practitioners
C. a significant number of adherents among practitioners
D. complete support by practitioners
Difficulty: Easy


A. analyze a relatively small number of stocks
B. analyze all stocks which are publicly traded
C. are redundant
D. devote their attention to market timing rather than fundamental analysis
Difficulty: Easy


A. analyze the entire universe of stocks
B. assume that markets are inefficient
C. treat market index as a baseline portfolio upon which an active portfolio is constructed
D. focus on selecting the best performing bogey
Difficulty: Easy

18-37
41. Active portfolio management consists of __________.

I. market timing
II. security selection
III. sector selection within given markets
IV. indexing
A. I and II only
B. II and III only
C. I, II and III only
D. I, II, III and IV
Difficulty: Easy

42. A market timing strategy is one where asset allocation in the stock market __________
when one forecasts the stock market will outperform treasury bills.
A. decreases
B. increases
C. remains the same
D. may increase or decrease
Difficulty: Easy

43. In the Treynor-Black model, the contribution of individual security to the active portfolio
should be based primarily on the stock's _________.
A. alpha
B. beta
C. the residual variance
D. appraisal ratio
Difficulty: Medium

18-38
44. If all ___ are ___ in the Treynor-Black model, there would be no reason to depart from the
passive portfolio.
A. alphas; zero
B. alphas; positive
C. betas; positive
D. standard deviations; positive
Difficulty: Medium

45. In the Treynor-Black model, the weight of each analyzed security in the portfolio should
be proportional to its __________.
A. alpha/beta
B. alpha/residual variance
C. beta/residual variance
D. none of the above
Difficulty: Easy

46. The critical variable in the determination of the success of the active portfolio is the
stock's __________.
A. alpha/nonsystematic risk
B. alpha/systematic risk
C. delta/nonsystematic risk
D. delta/systematic risk
Difficulty: Medium

47. Consider the theory of active portfolio management. Stocks A and B have the same
positive alpha and the same nonsystematic risk. Stock A has a higher beta than stock B. You
should want __________ in your active portfolio.
Difficulty: Medium

18-39
and non-systematic risk. Stock A has higher positive alpha than stock B. You should want
__________ in your active portfolio.
Difficulty: Medium

49. The market timing form of active portfolio management relies on __________ forecasting
and the security selection form of active portfolio management relies on __________
forecasting.
A. macroeconomic; macroeconomic
B. macroeconomic; microeconomic
C. microeconomic; macroeconomic
D. microeconomic; microeconomic
Difficulty: Medium

50. Active portfolio managers try to construct a risky portfolio with _______.

A. a higher Sharpe measure than a passive strategy
B. a lower Sharpe measure than a passive strategy
C. the same Sharpe measure as a passive strategy
D. very few securities
Difficulty: Medium

51. In performance measurement the bogey portfolio is designed to _________.

A. measure the returns to a completely passive strategy
B. measure the returns to a similar active strategy
C. measure the returns to a given investment style
D. equal the return on the S&P500
Difficulty: Medium

18-40
52. __________ portfolio manager(s) experience streaks of abnormal returns which are hard
to label as lucky outcomes, and ____ anomalies in realized returns have been sufficiently
persistent such that portfolio managers could use them to beat a passive strategy over
prolonged periods.
A. No; no
B. No; some
C. Some; no
D. Some; some
Difficulty: Medium

53. A passive benchmark portfolio is _______________.

I. a portfolio where the asset allocation across broad asset classes is neutral and not
determined by forecasts of performance of the different asset classes
II. one where an indexed portfolio is held within each asset class
III. often called the bogey
A. I only
B. I and III only
C. II and III only
D. I, II and III
Difficulty: Medium

54. The correct measure of timing ability is ____________ for a portfolio manager who
correctly forecasts 55% of bull markets and 55% of bear markets.
A. -5%
B. 5%
C. 10%
D. 95%
Timing ability = 0.55 + 0.55 - 1 = 0.1
Difficulty: Medium

18-41
55. It is very hard to statistically verify abnormal fund performance because of all except
which one of the following?
A. Inevitably some fund managers experience streaks of good performance that may just be
due to luck
B. The noise in realized rates of return is so large as to make it hard to identify abnormal
performance in competitive markets
C. Portfolio composition is rarely stable long enough to identify abnormal performance
D. Even if successful, there is really not much value to be added by active strategies such as
market timing
Difficulty: Medium

56. Stocks A and B have alphas of .01 and betas of .90. Stock A has a residual variance of .
020 while stock B has a residual variance of .016. If stock A represents 2% of an active
portfolio, stock B should represent __________ of an active portfolio.
A. 1.6%
B. 2.0%
C. 2.2%
D. 2.5%
Difficulty: Medium

18-42
70% of all bear markets. The correct measure of timing ability for Kevin Krueger is
__________.
A. 20%
B. 60%
C. 75%
D. 120%
Timing ability = 0.50 + 0.70 - 1 = 0.2
Difficulty: Easy

70% of all bear markets. The value of Kevin Krueger's imperfect forecasting ability is
__________.
A. $30,000
B. $67,500
C. $108,750
D. $217,500
Difficulty: Medium

18-43
59. Chuck Douglass, an imperfect forecaster correctly predicts 57% of all bull markets and
68% of all bear markets. Roy Simmonds is a perfect forecaster. If Chuck Douglass is able to
charge a fee of $125,000, the fee that Roy Simmonds should charge is __________. Assume
that both forecasters manage similar size funds.
A. $31,250
B. $200,000
C. $500,000
D. $625,000
Difficulty: Medium

60. A mutual fund invests in large-capitalization stocks. Its performance should be measured
against which one of the following?
A. Russell 2000 index
B. S&P 500 index
C. Wilshire 5000 index
D. Dow Jones Industrial Average
Difficulty: Easy

61. Assume you purchased a rental property for $100,000 and sold it one year later for
$115,000 (there was no mortgage on the property). At the time of the sale, you paid $3,000 in
commissions and $1,000 in taxes. If you received $10,000 in rental income (all received at the
end of the year), what annual rate of return did you earn?
A. 6%
B. 11%
C. 20%
D. 25%
(100,000 + 3000 + 1,000)(1 + r)1 = (115,000 + 10,000); r = 20.19%
Difficulty: Medium

18-44
The table presents the actual return of each sector of the manager's portfolio in column (1),
the fraction of the portfolio allocated to each sector in column (2), the benchmark or neutral
sector allocations in column (3), and the returns of sector indexes in column 4.

62. What was the manager's return in the month?

A. 2.07%
B. 2.21%
C. 2.24%
D. 4.80%
Actual = 0.60 x 3.0% + .30 x 1.3% + .10 x 0.5% = 2.24%
Difficulty: Medium

63. What was the bogey's return in the month?

A. 2.07%
B. 2.21%
C. 2.24%
D. 4.80%
Bogey = 0.50 x 3.2% + .40 x 1.4% + .10 x 0.5% = 2.21%
Difficulty: Medium

18-45
64. What was the manager's over or under performance for the month?
A. Under performance = 0.03%
B. Over performance = 0.03%
C. Over performance = 0.14%
D. Under performance = 3%
Over performance = Actual - Bogey = 2.24% - 2.21% = 0.03%
Difficulty: Medium

65. What is the contribution of security selection to relative performance?

A. -0.15%
B. 0.15%
C. -0.3%
D. 0.3%
Difficulty: Hard

18-46
66. What is the contribution of asset allocation to relative performance?

A. -0.18%
B. 0.18%
C. -0.15%
D. 0.15%
Difficulty: Hard

67. Morningstar's RAR produce results which are similar but not identical to ________.
A. Jensen's alpha
B. M2
C. the Treynor ratio
D. the Sharpe ratio
Difficulty: Medium

68. The Treynor-Black Model assumes security markets are _________.

A. completely efficient
B. nearly efficient
C. very inefficient
D. random walks
Difficulty: Easy

18-47
69. The appraisal ratio is equal to the stock's ____ divided by its ______.
A. diversifiable risk; beta
B. beta; alpha
C. alpha; beta
D. alpha; diversifiable risk
Difficulty: Medium

70. Empirical tests to date show ______________.

A. that many investors have earned large rewards by market timing
B. little evidence of market timing ability
C. clear cut evidence of substantial market timing ability
D. evidence that absolutely no market timing ability exists
Difficulty: Easy

A. 0.58%
B. 0.68%
C. 0.78%
D. 0.88%
P = 21/17 = 1.235
Rp = (.13 x 1.235) + (-.235 x.05) = 14.88%
M2 = 14.88 - 14.00 = 0.88%

Difficulty: Medium

18-48
A. 2.15%
B. 2.76%
C. 2.94%
D. 3.14%
P = 16/19 = .84
Rp = (.84 x .17) + (.16 x .0 4) = 14.94%
M2 = 14.94 - 12.00 = 2.94%

Difficulty: Medium

A. .1143
B. .1233
C. .1354
D. .1477
Treynor measure = (.13 - .05)/0.7 = 0.1143
Difficulty: Medium

A. .0833
B. .1083
C. .1114
D. .1163
Treynor measure = (.16 - .06)/1.2 = 0.0833
Difficulty: Medium

18-49
A. .3978
B. .4158
C. .4563
D. .4706
Sharpe measure = (.13 - .05)/.17 = 0.4706
Difficulty: Medium

A. .4757
B. .5263
C. .6842
D. .7252
Sharpe measure = (.16 - .06)/.19 = 0.5263
Difficulty: Medium

A. .017
B. .034
C. .067
D. .078
Jensen measure = .13 - [.05 + 0.7(.14 - .05)] = 0.017
Difficulty: Medium

18-50
A. .017
B. .028
C. .036
D. .078
Jensen measure = .16 - [.06 + 1.2(.12 - .06)] = 0.028
Difficulty: Medium

79. The portfolio that contains the benchmark asset allocation against which a manager will
be measured is often called _____________.
B. the Vanguard Index
C. Jensen's alpha
D. the Treynor measure
Difficulty: Easy

80. An attribution analysis will NOT likely contain which of the following components?
A. Asset allocation
B. Index returns
C. Risk free returns
D. Security selection
Difficulty: Easy

18-51
81. Which of the following investment strategies would have produced the highest returns in
the time period since 1926?
A. T bills portfolio
B. S&P 500 index fund
C. Perfect market timing
D. Random stock selection
Difficulty: Easy

82. What phrase might be used as a substitute for the Treynor-Black model developed in
1973?
A. Solely active management
B. Enhanced index approach
C. Passive management
D. Random selection
Difficulty: Easy

83. What is the term for the process used to assess portfolio manager performance?
A. Active analysis
B. Attribution analysis
C. Passive analysis
D. Treynor Black Analysis
Difficulty: Easy

84. A fund has excess performance of 1.5%. In looking at the fund's investment breakdown
you see that the fund overweighed equities relative to the benchmark and the average return
on the fund's equity portfolio was slightly lower than the equity benchmark return. The excess
performance for this fund is probably due to _______________.
A. security selection ability
B. better sector weightings in the equity portfolio
C. the asset allocation decision
D. finding securities with positive alphas
Difficulty: Medium

18-52
85. For a market timer the _____________ will be higher when RM is higher.

A. portfolio's alpha and beta
B. portfolio's unsystematic risk
C. portfolio's beta and slope of the characteristic line
D. security selection component of the portfolio
Difficulty: Medium

86. The Treynor-Black model combines an actively managed portfolio with an efficiently

diversified portfolio in order to _______________________.
I. improve the diversification of the overall portfolio
II. improve the overall portfolio's Sharpe ratio
III. reach a higher CAL than otherwise would be possible
A. I only
B. I and II only
C. II and III only
D. I, II and III
Difficulty: Medium

and the same positive alpha. Stock A has higher nonsystematic risk than stock B. You should
want __________ in your active portfolio.
Difficulty: Medium

18-53

Chapter 18 - Portfolio Performance Evaluation

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Chapter 18 - Portfolio Performance Evaluation

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Chapter 18 - Portfolio Performance Evaluation

Multiple Choice Questions

2. The comparison universe is __________.

3. Which one of the following performance measures is the Sharpe measure?

4. The M2 measure is a variant of ________________.

10. Most professionally managed equity funds __________.

11. What is the T2 measure for portfolio A?

12. What is the M2 measure for portfolio B?

15. Which one of the following is largely based on forecasts of macroeconomic factors?

20. The total excess return on the managed portfolio was __________.

23. The total extra return on the managed portfolio was __________.

29. The M2 measure of portfolio performance was developed by ______________.

31. Perfect timing ability is equivalent to having __________ on the market portfolio.

38. The theory of efficient frontiers has __________.

39. In the Treynor-Black model security analysts __________.

40. In the Treynor-Black model security analysts __________.

41. Active portfolio management consists of __________.

50. Active portfolio managers try to construct a risky portfolio with _______.

51. In performance measurement the bogey portfolio is designed to _________.

53. A passive benchmark portfolio is _______________.

62. What was the manager's return in the month?

63. What was the bogey's return in the month?

65. What is the contribution of security selection to relative performance?

66. What is the contribution of asset allocation to relative performance?

68. The Treynor-Black Model assumes security markets are _________.

70. Empirical tests to date show ______________.

85. For a market timer the _____________ will be higher when RM is higher.

86. The Treynor-Black model combines an actively managed portfolio with an efficiently