When estimating a Sharpe ratio, would it make sense to use the average excess real return that accounts for inflation?
No. The input should use nominal data and not use average excess real return data.
What: Use of average excess real return that accounts for inflation
When: In estimating a Sharpe ratio estimation
Sharpe ratio also called reward to volatility ratio represents extra returns per extra risk. It was named after William Sharpe.
While estimating a Sharpe ratio, all items are presented in nominal figures, the input should also use nominal data and not the average excess real return data.
Use the following data in answering CFA Questions:
Investor “satisfaction” with portfolio increases with expected return and decreases with variance according to the “utility” formula: U = E(r) - ½ Aσ2 where A = 4.
Question: The variable ( A ) in the utility formula represents the:
a. Investor’s return requirement.
b. Investor’s aversion to risk.
c. Certainty equivalent rate of the portfolio.
d. Preference for one unit of return per four units of risk.
Two investment advisers are comparing performance. One averaged a 19% return and the other a 16% return. However, the beta of the first adviser was 1.5, while that of the second was 1.
a. Can you tell which adviser was a better selector of individual stocks (aside from the issue of general movements in the market)?
b. If the T-bill rate were 6% and the market return during the period were 14%, which adviser would be the superior stock selector?
c. What if the T-bill rate were 3% and the market return 15%?
Which of the following sources of market inefficiency would be most easily exploited?
a. A stock price drops suddenly due to a large block sale by an institution.
b. A stock is overpriced because traders are restricted from short sales.
c. Stocks are overvalued because investors are exuberant over increased productivity in the economy.
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