[2008] Topic 72: The Capital Asset Pricing Model and Its Application to Perfo only, standard, returns

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AIM 1: List the CAPM’s underlying assumptions.

1、The assumption that returns are normally distributed means that investors:

A) are risk averse.

B) have the same horizon.

C) do not need to consider transactions costs.

D) only consider the mean and standard deviation of the returns.

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3、The Sortino ratio is most similar to the:

A) Treynor ratio.

B) information ratio.

C) relative tracking error ratio.

D) Sharpe ratio.

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The correct answer is D

The Sortino ratio is similar to the Sharpe ratio except for two changes. We replace the risk-free rate with a minimum acceptable return, denoted Rmin, and we replace the standard deviation with a type of semivariance.

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6、The Sortino ratio is a measure of a portfolio’s return above:

A) zero divided by the standard deviation.

B) the market return divided by beta.

C) a minimal acceptable return divided by downside deviation.

D) the market return divided by the standard deviation.

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The correct answer is C

The definition of the Sortino ratio is a predefined minimal acceptable return divided by downside deviation.

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AIM 6: Compute and interpret tracking error, the information ratio, and the Sortino ratio.

1、In the Sortino ratio, the excess return is divided by the:

A) standard deviation.

B) maximum drawdown.

C) standard deviation using only the returns below a minimum level

D) VAR.

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The correct answer is C

The Sortino ratio examines the downside risk of returns. It is calculated as the portfolio return minus the minimum acceptable return (MAR) divided by a standard deviation that only uses returns below the MAR. It is similar to the target semivariance. The other responses refer to other measures of risk-adjusted performance. The Sharpe ratio divides the excess return above the risk-free rate by the standard deviation. An example of a risk-adjusted return on invested capital (RAROC) measure would be to divide the portfolio’s expected return by the VAR. The RoMAD (return over maximum drawdown) is the average portfolio return divided by the maximum drawdown. Drawdown refers to the percentage difference between the highest and lowest portfolio values during a period.