Sample Questions and Answers
Which performance metric helps to evaluate how much excess return a portfolio generates per unit of total risk?
A) Sharpe ratio
B) Treynor ratio
C) Information ratio
D) Jensen’s alpha
Answer: A
If a portfolio has a tracking error of 5% and the excess return relative to its benchmark is 4%, what is the portfolio’s information ratio?
A) 0.80
B) 0.50
C) 1.20
D) 1.00
Answer: A
What is the primary advantage of using Jensen’s alpha for portfolio performance evaluation?
A) It adjusts returns for both systematic and unsystematic risk.
B) It accounts for the total risk of a portfolio.
C) It reflects the portfolio’s return in excess of the expected return based on beta.
D) It directly compares the portfolio’s risk to its benchmark.
Answer: C
What does a positive information ratio indicate?
A) The portfolio is taking on excessive risk relative to its returns.
B) The portfolio is underperforming the benchmark.
C) The portfolio is generating a positive excess return relative to its tracking error.
D) The portfolio has an alpha that is above the risk-free rate.
Answer: C
The Treynor ratio is most useful for evaluating:
A) Highly diversified portfolios.
B) Portfolios with high unsystematic risk.
C) Individual stocks.
D) The performance of portfolios with high levels of systematic risk.
Answer: A
Which of the following would result in an increase in a portfolio’s Sharpe ratio?
A) An increase in portfolio risk without a change in return.
B) A decrease in portfolio risk with no change in return.
C) A decrease in the risk-free rate.
D) A decrease in the portfolio’s return.
Answer: B
The primary difference between the Sharpe ratio and the Treynor ratio is that the Sharpe ratio uses:
A) Total risk (standard deviation) as the denominator, while the Treynor ratio uses systematic risk (beta).
B) Only systematic risk as the denominator, while the Treynor ratio uses total risk.
C) Jensen’s alpha as the numerator, while the Treynor ratio uses excess return.
D) Tracking error in its calculation, while the Treynor ratio does not.
Answer: A
In portfolio performance evaluation, a high tracking error typically suggests that:
A) The portfolio’s returns are highly correlated with the benchmark’s returns.
B) The portfolio is closely aligned with the benchmark’s performance.
C) The portfolio is deviating significantly from the benchmark’s returns.
D) The portfolio is not being actively managed.
Answer: C
A portfolio manager’s goal in active management is to achieve:
A) A return equal to the benchmark’s return.
B) A return that exceeds the benchmark’s return after adjusting for risk.
C) A return that matches the risk-free rate.
D) A return that does not exceed the benchmark’s return.
Answer: B
If a portfolio has a negative Treynor ratio, it suggests that:
A) The portfolio is underperforming relative to its systematic risk.
B) The portfolio is outperforming the market after adjusting for risk.
C) The portfolio’s risk is much lower than the market’s.
D) The portfolio is taking on excessive risk.
Answer: A
Which of the following is the most suitable performance metric when comparing two portfolios with similar levels of diversification but different betas?
A) Sharpe ratio
B) Jensen’s alpha
C) Treynor ratio
D) Information ratio
Answer: C
If a portfolio has a higher Sharpe ratio than its benchmark, it means:
A) The portfolio has outperformed the benchmark on a risk-adjusted basis.
B) The portfolio has taken on more risk than the benchmark.
C) The portfolio has a higher total return than the benchmark.
D) The portfolio has a lower alpha than the benchmark.
Answer: A
A portfolio manager aims to maximize the alpha. Which of the following actions is most likely to achieve this?
A) Increasing the portfolio’s beta to increase exposure to market risk.
B) Taking on more unsystematic risk.
C) Selecting securities that outperform the market after adjusting for their risk.
D) Reducing the tracking error of the portfolio.
Answer: C
If a portfolio has an information ratio of 2.5, it means that:
A) The portfolio has earned 2.5 times the benchmark’s return.
B) The portfolio has outperformed its benchmark by 2.5 times per unit of tracking error.
C) The portfolio is taking 2.5 times more risk than the benchmark.
D) The portfolio’s alpha is 2.5 times higher than its benchmark.
Answer: B
The Sharpe ratio assumes that:
A) The portfolio’s returns are normally distributed.
B) The portfolio’s returns are skewed to the right.
C) The portfolio’s returns are unpredictable.
D) The portfolio’s returns are consistent over time.
Answer: A
Which of the following statements is true regarding the Treynor ratio?
A) The Treynor ratio measures excess return per unit of total risk.
B) The Treynor ratio is most suitable for evaluating portfolios with a significant amount of unsystematic risk.
C) The Treynor ratio measures excess return per unit of systematic risk (beta).
D) The Treynor ratio adjusts for both systematic and unsystematic risk.
Answer: C
A portfolio manager’s objective in terms of Jensen’s alpha is to:
A) Achieve the highest possible Sharpe ratio.
B) Maximize the portfolio’s risk-adjusted return relative to its benchmark.
C) Achieve a positive alpha, indicating outperformance of the market after adjusting for risk.
D) Minimize tracking error relative to the benchmark.
Answer: C
If a portfolio’s return is above the market’s return but with the same beta, this means that:
A) The portfolio has earned a higher alpha.
B) The portfolio is underperforming relative to its risk.
C) The portfolio has lower systematic risk than the market.
D) The portfolio has a higher tracking error than the benchmark.
Answer: A
In portfolio performance evaluation, a benchmark is useful for:
A) Identifying the optimal level of diversification.
B) Providing a risk-free comparison for portfolio returns.
C) Assessing the performance of a portfolio relative to its market or peer group.
D) Calculating the portfolio’s alpha.
Answer: C
The information ratio is most closely associated with:
A) The performance of the portfolio relative to the market.
B) The portfolio’s ability to track the benchmark’s performance.
C) The portfolio’s alpha adjusted for its tracking error.
D) The portfolio’s excess return adjusted for its beta.
Answer: C
Which of the following describes the main limitation of using the Sharpe ratio in portfolio evaluation?
A) It does not adjust for the portfolio’s beta.
B) It ignores systematic risk and focuses only on total risk.
C) It may be misleading if the portfolio returns are not normally distributed.
D) It requires a higher risk-free rate to be effective.
Answer: C
The Treynor ratio is more appropriate for evaluating:
A) Portfolios with low beta.
B) Highly diversified portfolios where unsystematic risk is minimal.
C) Portfolios with significant unsystematic risk.
D) Portfolios with no correlation to the market.
Answer: B
In portfolio performance evaluation, if a portfolio’s Sharpe ratio is greater than its benchmark’s, this suggests:
A) The portfolio has a higher total return than its benchmark.
B) The portfolio has outperformed the benchmark on a risk-adjusted basis.
C) The portfolio has a higher risk level than the benchmark.
D) The portfolio’s returns are skewed more positively than the benchmark.
Answer: B
The concept of “active risk” in portfolio performance evaluation refers to:
A) The risk associated with market fluctuations.
B) The volatility of returns relative to the risk-free rate.
C) The risk generated by the portfolio’s deviations from the benchmark.
D) The systematic risk of the portfolio.
Answer: C
Which of the following statements best describes a portfolio with a negative Jensen’s alpha?
A) The portfolio is outperforming the market after adjusting for risk.
B) The portfolio is underperforming the market after adjusting for risk.
C) The portfolio has no systematic risk.
D) The portfolio has higher returns than the benchmark with lower risk.
Answer: B
A portfolio with a higher alpha compared to its benchmark is indicative of:
A) Higher total risk.
B) Stronger market correlation.
C) Superior risk-adjusted performance.
D) Lower tracking error.
Answer: C
When evaluating a portfolio’s performance, the use of tracking error helps to assess:
A) The portfolio’s overall risk relative to the market.
B) The extent to which the portfolio deviates from its benchmark.
C) The portfolio’s returns relative to the risk-free rate.
D) The performance of the portfolio’s individual securities.
Answer: B
The Sharpe ratio is best used for evaluating portfolios:
A) That have high correlation with a benchmark.
B) With significant exposure to systematic risk.
C) With low diversification and significant unsystematic risk.
D) That include both systematic and unsystematic risk.
Answer: D
Which of the following performance metrics focuses on evaluating the performance of a portfolio relative to its systematic risk (beta)?
A) Information ratio
B) Treynor ratio
C) Sharpe ratio
D) Jensen’s alpha
Answer: B
If a portfolio’s return exceeds its expected return based on its level of systematic risk (beta), the portfolio’s Jensen’s alpha is:
A) Positive.
B) Negative.
C) Zero.
D) Uncertain, as alpha depends on the Sharpe ratio.
Answer: A
The information ratio is calculated as the portfolio’s excess return divided by its:
A) Beta.
B) Tracking error.
C) Total risk.
D) Risk-free rate.
Answer: B
The primary goal of using the Treynor ratio in portfolio evaluation is to:
A) Evaluate the portfolio’s performance with respect to both systematic and unsystematic risk.
B) Evaluate the portfolio’s performance relative to its beta or market risk.
C) Evaluate the portfolio’s performance relative to its total risk.
D) Evaluate the portfolio’s risk-adjusted performance without considering the risk-free rate.
Answer: B
A portfolio with a high information ratio is likely to:
A) Have a high tracking error.
B) Perform similarly to its benchmark.
C) Deliver excess returns relative to its benchmark for each unit of tracking error.
D) Have a lower alpha than its benchmark.
Answer: C
A positive Treynor ratio implies:
A) The portfolio is taking on less systematic risk than the market.
B) The portfolio is outperforming the market after adjusting for systematic risk.
C) The portfolio has a higher tracking error than its benchmark.
D) The portfolio is underperforming the market after adjusting for risk.
Answer: B
In performance evaluation, the excess return of a portfolio is calculated as:
A) The portfolio’s return minus the risk-free rate.
B) The portfolio’s return minus the benchmark return.
C) The portfolio’s return minus its beta.
D) The portfolio’s total risk minus its unsystematic risk.
Answer: A
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