Exercises on Performance Evaluation

1.__________ did not develop a popular method for risk-adjusted performance evaluation of mutual funds.
A) Eugene Fama
B) Michael Jensen
C) William Sharpe
D) Jack Treynor
E) A and B
Answer: A Difficulty: Easy
Rationale: Michael Jensen, William Sharpe, and Jack Treynor developed popular models for mutual fund performance evaluation.
2. Suppose two portfolios have the same average return, the same standard deviation of returns, 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 as there is no data on the alpha of the portfolio
E) none of the above is true.
Answer: B Difficulty: Moderate
Rationale: The Sharpe index is a measure of average portfolio returns (in excess of the risk free return) per unit of total risk (as
measured by standard deviation).
3. Suppose the risk-free return is 4%. The beta of a managed portfolio is 1.2, the alpha is 1%, and the average return is 14%. Based on Jensen's
measure of portfolio performance, you would calculate the return on the market portfolio as
A) 11.5%
B) 14%
C) 15%
D) 16%
E) none of the above
Answer: A Difficulty: Difficult
Rationale: 1% = 14% - [4% + 1.2(x - 4%)]; x = 11.5%.
4. Suppose a particular investment earns an arithmetic return of 10% in year 1, 20% in year 2 and 30% in year 3. The geometric average return
for the year period will be __________.
A) greater than the arithmetic average return
B) equal to the arithmetic average return
C) less than the arithmetic average return
D) equal to the market return
E) cannot tell from the information given
Answer: C Difficulty: Moderate
Rationale: The geometric mean will always be less than the arithmetic mean unless the returns in all periods are equal (in which case
the two means will be equal).
5.

Suppose you buy 100 shares of Abolishing Dividend Corporation at the beginning of year 1 for $80. Abolishing Dividend
Corporation pays no dividends. The stock price at the end of year 1 is $100, the price $120 at the end of year 2, and the price is $150
at the end of year 3. The stock price declines to $100 at the end of year 4, and you sell your 100 shares. For the four years, your
geometric average return is
A) 0.0%
B) 1.0%
C) 5.7%
D) 9.2%
E) 34.5%
Answer: C Difficulty: Difficult
Rationale: [(1.25)(1.20)(1.25)(0.6667)]1/4 - 1.0 = 5.7%

6. You want to evaluate three mutual funds using the Sharpe measure for performance evaluation. The risk-free return during the sample period
is 6%. The average returns, standard deviations and betas for the three funds are given below, as is the data for the S&P 500 index.

The fund with the highest Sharpe measure is __________.

A) Fund A
B) Fund B
C) Fund C

D) Funds A and B are tied for highest

E) Funds A and C are tied for highest
Answer: C Difficulty: Moderate
Rationale: A: (24% - 6%)/30% = 0.60; B: (12% - 6%)/10% = 0.60; C: (22% - 6%)/20% = 0.80; S&P 500: (18% - 6%)/16% = 0.75.
7. You want to evaluate three mutual funds using the Treynor measure for performance evaluation. The risk-free return during the sample period
is 6%. The average returns, standard deviations, and betas for the three funds are given below, in addition to information regarding the
S&P 500 index.

The fund with the highest Treynor measure is __________.

A) Fund A
B) Fund B
C) Fund C
D) Funds A and B are tied for highest
E) Funds A and C are tied for highest
Answer: A Difficulty: Difficult
Rationale: A: (13% - 6%)/0.5 = 14; B: (19% - 6%)/1.0 = 13; C: (25% - 6%)/1.5 = 12.7; S&P 500: (18% - 6%)/1.0 = 12.
Use the following to answer questions 8-10:
The following data are available relating to the performance of Sooner Stock Fund and the market portfolio:
8.

What is the Sharpe measure of performance evaluation for Sooner Stock Fund?
A) 1.33%
B) 4.00%
C) 8.67%
D) 38.6%
E) 37.14%
Answer: D Difficulty: Moderate
Rationale: (20% - 3%)/44% = 0.386, or 38.6%.

9.

What is the Treynor measure of performance evaluation for Sooner Stock Fund?
A) 1.33%
B) 4.00%
C) 8.67%
D) 9.44%
E) 37.14%
Answer: D Difficulty: Moderate
Rationale: (20% - 3%)/1.8 = 9.44%.

10.

Calculate the Jensen measure of performance evaluation for Sooner Stock Fund.
A) 2.6%
B) 4.00%
C) 8.67%
D) 31.43%
E) 37.14%
Answer: A Difficulty: Moderate
Rationale: P = 20% - [3% + 1.8(11% - 3%)] = 2.6%.