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19. Performance Evaluation questions with answers.
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19. Performance Evaluation questionswith answers.
The first step of performance evaluation is:
A. attributing performance.
B. measuring relative returns.
C. measuring absolute returns. ANS -C is correct.
The performance evaluation process begins with the measurement of absolute returns. Absolute returns
are the holding-period returns. They measure the total gain or loss that an investor owning a security
achieved over the holding period compared with the investment at the beginning of the period. Holding-
period returns usually come from the changes in the price of the security between the beginning and
the end of the period, as well as the income received over the period (dividend, interest). B and A are
incorrect because measuring relative returns and attributing performance are the third and fourth steps
of the performance evaluation process, respectively.
The Sharpe ratio is used in the performance evaluation process to:
A. adjust return for risk.
B. attribute performance.
C. measure absolute returns. ANS -A is correct.
The Sharpe ratio evaluates the reward for each unit of risk. B and C are incorrect because the Sharpe
ratio is not used in the attribution of performance or in the measurement of absolute performance.
The measurement of relative returns involves comparing the fund manager's holding-period return with:
A. a measure of risk.
B. the return on a benchmark.
, C. the fund manager's past performance. ANS -B is correct.
The measurement of relative returns involves comparing the fund manager's holding-period return with
the return on an appropriate benchmark. A is incorrect because measures of risk, such as the standard
deviation, are used to calculate risk-adjusted returns (the second step of the performance evaluation
process) rather than relative returns (the third step of the performance evaluation process). C is
incorrect because the fund manager's past performance is not an appropriate benchmark.
The measure that best reflects the variability of returns around the mean return is the:
A. standard deviation.
B. reward-to-risk ratio.
C. downside deviation. ANS -A is correct.
The standard deviation reflects the variability (or volatility) of returns around the mean (or average)
return. B is incorrect because the reward-to-risk ratio is a measure of risk-adjusted performance, which
indicates how much return was generated per unit of risk. C is incorrect because the downside deviation
is calculated by using only deviations that are negative; the downside deviation considers only the
outcomes that are less than the mean return.
The measure that is best suited for investors who dislike losses more than they like equivalent gains is
the:
A. Sharpe ratio.
B. standard deviation.
C. downside deviation. ANS -C is correct.
The downside deviation focuses only on the negative deviations—that is, the returns that are less than
the mean return. Thus, it is an appropriate measure of risk for investors who dislike losses (negative
outcomes) more than they like equivalent gains (positive outcomes). A is incorrect because the Sharpe
ratio is a measure of risk-adjusted performance that reflects the excess return on a portfolio per unit of
risk. B is incorrect because the standard deviation considers all outcomes, both above and below the
mean return. It is a better measure for investors who like gains as much as they dislike equivalent losses.
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