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Unformatted text preview: Chapter 18 - Performance Evaluation and Active Portfolio Management Chapter 18 Performance Evaluation and Active Portfolio Management 1. d 2. Using a financial calculator or spreadsheet the rate of return is 16.8% 3. Using a financial calculator or spreadsheet the internal rate of return is 7.5% 4. a. E(r) Portfolio A 11% 10% 0.8 Portfolio B 14% 31% 1.5 Market index 12% 20% 1.0 Risk-free asset 6% 0% 0.0 The alphas for the two portfolios are: A = 11% [6% + 0.8(12% 6%)] = 0.2% B = 14% [6% + 1.5(12% 6%)] = 1.0% Ideally, you would want to take a long position in Portfolio A and a short position in Portfolio B. b. If you hold only one of the two portfolios, then the Sharpe measure is the appropriate criterion: S A = 5 . 10 6 11 =- S B = 26 . 31 6 14 =- Therefore, using the Sharpe criterion, Portfolio A is preferred. 5. We first distinguish between timing ability and selection ability. The intercept of the scatter diagram is a measure of stock selection ability. If the manager tends to have a positive excess return even when the markets performance is merely neutral (i.e., the market has zero excess return) then we conclude that the manager has, on average, made good stock picks. In other words, stock selection must be the source of the positive excess returns. 18-1 Chapter 18 - Performance Evaluation and Active Portfolio Management Timing ability is indicated by the curvature of the plotted line. Lines that become steeper as you move to the right of the graph show good timing ability. The steeper slope shows that the manager maintained higher portfolio sensitivity to market swings (i.e., a higher beta) in periods when the market performed well. This ability to choose more market- sensitive securities in anticipation of market upturns is the essence of good timing. In contrast, a declining slope as you move to the right indicates that the portfolio was more sensitive to the market when the market performed poorly, and less sensitive to the market when the market performed well. This indicates poor timing. We can therefore classify performance ability for the four managers as follows: Selection Ability Timing Ability A Bad Good B Good Good C Good Bad D Bad Bad 6. a. Actual: (0.70 2.0%) + (0.20 1.0%) + (0.10 0.5%) = 1.65% Bogey: (0.60 2.5%) + (0.30 1.2%) + (0.10 0.5%) = 1.91% Under performance = 1.91% 1.65% = 0.26% b. Security Selection: Market Portfolio Performance Index Performance Excess Performance Managers Portfolio Weight Contribution Equity 2.0% 2.5%-0.5% 0.70-0.35% Bonds 1.0% 1.2%-0.2% 0.20-0.04% Cash 0.5% 0.5% 0.0% 0.10 0.00% Contribution of security selection:-0.39% c. Asset Allocation: Market Actual Weight Benchmark Weight Excess Weight Index Return Minus Bogey Contribution Equity 0.70 0.60 0.10 0.59% 0.059% Bonds 0.20 0.30-0.10-0.71% 0.071% Cash 0.10 0.10 0.00-1.41% 0.000% Contribution of asset allocation: 0.130% Summary Security selection-0.39% Asset allocation 0.13% Excess performance-0.26% 18-2 Chapter 18 - Performance Evaluation and Active Portfolio Management...
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- Spring '09