Question 1

Most funds show a positive performance compared to a market average.

Accepted Answer

Most funds do not consistently outperform the market average over the long term, as evidenced by numerous studies including the SPIVA Scorecard, which shows a majority of actively managed funds underperform their benchmarks.

Question 2

A portfolio manager with a beta less than one should be expected to provide higher returns than the market.

Accepted Answer

A portfolio manager with a beta less than one should be expected to provide lower returns than the market, as the portfolio is less volatile than the market and thus has less potential for gains.

Question 3

The effectiveness of portfolio diversification can be measured by the coefficient of determination, which is the correlation between excess returns on the market and those on the fund.

Accepted Answer

The coefficient of determination is a measure of how closely the excess returns on a fund track the excess returns on the market. A high coefficient of determination indicates that the fund is well-diversified and that its returns are not highly correlated with the market.

Question 4

Michael Jensen uses the security market line to evaluate excess returns on investments.

Accepted Answer

Michael Jensen uses the security market line to evaluate excess returns on investments.

Question 5

Over 20-year rolling periods, the worst performance by small company stocks was positive, according to Ibbotson and Associates.

Accepted Answer

According to Ibbotson and Associates, over 20-year rolling periods, the worst performance by small company stocks was still positive.

Question 6

When the U.S. T-bill rate is 5.75%, the excess returns on a portfolio earning 14% would be 8.25%.

Accepted Answer

In examining the performance of fund managers, the return measure commonly used is excess returns. Though the term excess returns has many definitions, the one most commonly used is total return on a portfolio (capital appreciation plus dividends) minus the risk-free rate; thus, excess returns represent returns over and above what could be earned on a riskless asset. The rate on U.S. government Treasury bills is often used to represent the risk-free rate of return in the financial markets (though other definitions are possible).

Question 7

In general, the best portfolio managers are those who earn the highest returns.

Accepted Answer

Adherence to objectives, as measured by risk exposure, is important in evaluating a fund manager because risk is one of the variables a money manager can directly control. While short-run return performance can be greatly influenced by unpredictable changes in the economy, the fund manager has almost total control in setting the risk level. He can be held accountable for doing what was specified or promised in regard to risk.

Question 8

Most law suits against fund managers are for poor performance in terms of return.

Accepted Answer

Most law suits against fund managers are NOT for poor performance in terms of return. They are usually filed for breach of fiduciary duty, fraud, mismanagement, or other forms of misconduct.

Question 9

Alpha must always be a positive number.

Accepted Answer

Alpha can be negative, indicating that the investment has underperformed relative to the benchmark.

Question 10

The wise money manager will generally adhere strictly to stated objectives.

Accepted Answer

Most lawsuits brought against money managers are not for inferior profit performance but for failure to adhere to stated risk objectives. Although it may be appropriate to shift the risk level in anticipation of changing market conditions (lower the beta at a perceived peak in the market), long-run adherence to risk objectives is advisable.

Question 11

R² is a good measure of efficient diversification.

Accepted Answer

R² is a measure of how well a regression line fits a set of data. In the context of efficient diversification, a high R² value indicates that the portfolio is well-diversified and that the assets in the portfolio are not highly correlated.

Question 12

Sharpe uses beta as a measure of risk.

Accepted Answer

The Sharpe ratio uses standard deviation as a measure of risk, not beta. Beta is used in the calculation of the Capital Asset Pricing Model (CAPM) to measure systematic risk.

Question 13

Treynor uses beta as a measure of risk.

Accepted Answer

Treynor uses beta as a measure of systematic risk, which is a component of overall risk. Therefore, the statement is true.

Question 14

Studies by Ippolito and Goodwin indicate that mutual fund managers are superior performers.

Accepted Answer

What the Ippolito article suggests is that mutual funds are efficient gatherers of information, and that, on average, they use the information well in their investment activities. However, there are costs associated with acquiring this information, and wise use of the information covers the cost of its acquisition.

Question 15

Major studies have shown that fund managers in general are unable to efficiently diversify the portfolios primarily due to a small number of securities.

Accepted Answer

Although many mutual funds invest in 80 to 100 securities to achieve effective diversification, this is often more than is necessary. A high degree of diversification can be achieved with between 10 and 20 efficiently selected stocks.

Question 16

A fund manager has almost total control over the beta of his portfolio.

Accepted Answer

Beta is a measure of the volatility or risk of an asset in relation to the overall market. As a fund manager can choose what assets are included in the portfolio and the weightings of each asset, they can also control the overall beta of the portfolio. This is done by adjusting the asset allocation of the portfolio, for example, by adding low-beta assets to reduce the overall beta, or high-beta assets to increase it. However, there are external factors that may affect the beta of the portfolio, such as changes in market conditions or investor sentiment, which are beyond the control of the fund manager.

Question 17

Under the Sharpe, Treynor, and Jensen approaches, the return measurement must be compared to risk in some form.

Accepted Answer

Three different approaches to compare returns to risk: the Sharpe approach, the Treynor approach, and the Jensen approach.

Question 18

Buying a mutual fund is a good way to diversify.

Accepted Answer

Buying a mutual fund allows an investor to own a diversified portfolio of assets, which helps to spread risk across multiple investments. Therefore, buying a mutual fund is a good way to diversify.

Question 19

The relationship between excess returns and the portfolio beta is represented by the market line.

Accepted Answer

The market line, also known as the security market line (SML), represents the relationship between excess returns (or required returns) and the systematic risk of a portfolio, which is measured by its beta. It shows what return investors should expect for a given level of risk, as determined by the market risk premium and the beta of the portfolio. Thus, the market line is a graphical representation of the capital asset pricing model (CAPM), which predicts that the expected return on an asset or portfolio is equal to the risk-free rate plus the beta of the asset or portfolio multiplied by the market risk premium.

Question 20

The Jensen study indicates that mutual fund managers tend to have very superior performances.

Accepted Answer

The Jensen study actually concluded that mutual fund managers do not consistently outperform the market after accounting for their fees and risk levels.

Quiz 22: Measuring Risks and Returns of Portfolio Managers

Most funds show a positive performance compared to a market average.

A portfolio manager with a beta less than one should be expected to provide higher returns than the market.

The effectiveness of portfolio diversification can be measured by the coefficient of determination, which is the correlation between excess returns on the market and those on the fund.

Michael Jensen uses the security market line to evaluate excess returns on investments.

Over 20-year rolling periods, the worst performance by small company stocks was positive, according to Ibbotson and Associates.

When the U.S. T-bill rate is 5.75%, the excess returns on a portfolio earning 14% would be 8.25%.

In general, the best portfolio managers are those who earn the highest returns.

Most law suits against fund managers are for poor performance in terms of return.

Alpha must always be a positive number.

The wise money manager will generally adhere strictly to stated objectives.

R2 is a good measure of efficient diversification.

Sharpe uses beta as a measure of risk.

Treynor uses beta as a measure of risk.

Studies by Ippolito and Goodwin indicate that mutual fund managers are superior performers.

Major studies have shown that fund managers in general are unable to efficiently diversify the portfolios primarily due to a small number of securities.

A fund manager has almost total control over the beta of his portfolio.

Under the Sharpe, Treynor, and Jensen approaches, the return measurement must be compared to risk in some form.

Buying a mutual fund is a good way to diversify.

The relationship between excess returns and the portfolio beta is represented by the market line.

The Jensen study indicates that mutual fund managers tend to have very superior performances.

R² is a good measure of efficient diversification.