What does the Sharpe ratio measure, and why is a higher Sharpe ratio generally considered better?
AThe Sharpe ratio compares a portfolio's return to the market return (alpha), so a higher Sharpe ratio always means the manager outperformed the benchmark index
BThe Sharpe ratio measures the total return of a portfolio without any adjustment for risk, so a higher number simply means higher absolute returns regardless of the volatility involved
CThe Sharpe ratio measures risk-adjusted return: it equals the portfolio's excess return over the risk-free rate divided by its standard deviation, so a higher ratio means the portfolio earned more return per unit of total risk taken
DThe Sharpe ratio measures only the downside risk of a portfolio, ignoring upside volatility entirely, making it the same as the Sortino ratio
An investor's portfolio has a beta of 1.5 relative to the S&P 500. If the S&P 500 drops 10% in a month, approximately how much would this investor's portfolio be expected to decline, all else equal?
AThe portfolio would be expected to gain 15%, because a high beta means the portfolio moves in the opposite direction of the market
BApproximately 15%, because a beta of 1.5 means the portfolio is expected to move 1.5 times as much as the market — for every 1% market decline, the portfolio declines roughly 1.5%
CApproximately 6.67%, because beta works inversely — a portfolio with beta greater than 1 is actually less sensitive to market moves than the market itself
DExactly 10%, because all equity portfolios move in lockstep with the market regardless of their beta
An analyst calculates that a portfolio's one-day 95% Value at Risk (VaR) is $500,000. What does this figure mean in practical terms?
AThe maximum possible loss on the portfolio in any single trading day is exactly $500,000 under all market conditions, with no possibility of exceeding that amount
BThere is a 95% probability that the portfolio will lose exactly $500,000 on any given day, no more and no less
CThe portfolio will generate at least $500,000 in profit on 95% of trading days, guaranteeing a minimum daily return
DOn 95% of trading days, the portfolio is expected to lose no more than $500,000 — equivalently, there is a 5% chance that the daily loss will exceed $500,000, but VaR says nothing about how large the loss could be in that worst 5% of days