(A)
Case Summary:
The finance committee of an endowment fund decides to shift part of its investment in an index fund to a portfolio which is professionally managed. Upon investigation by a committee member, he proposes to choose a portfolio which has greater alpha value.
Characters in the case: A Committee member
Adequate Information: Alpha Value which is a performance ratio to help an investor evaluate risk-adjusted performance of a portfolio.
To determine if the proposed portfolio with greater alpha value should be chosen.
Explanation of Solution
Given Information:
The committee member proposes to choose an investment portfolio which has greater alpha value. Only this ratio will not help to determine the performance of the portfolio. Alpha along with Sharpe ratio is often used to rank the performance an investment portfolio.
Alpha is a ratio which reflects the performance of an investment relative to benchmark index which means that a positive alpha shows that the fund has beaten benchmark by 1% and so higher the alpha, better the fund. But alpha is just a number and expressed in percentage so alpha along with Sharpe ratio is used to determine the performance of the investment on risk-adjusted basis. Sharpe ratio helps to determine the real return on each unit of portfolio. Higher the ratio, better the
Thus to conclude, a positive alpha alone cannot determine the performance of the investment portfolio to give the Sharpe measure higher than the benchmark.
(B)
To determine if positive alpha shows the performance of the portfolio is inferior.
Introduction: Alpha is a performance measure of an investment relative to benchmark index which means a positive alpha has beaten the benchmark index and so better the fund while Sharpe ratio along with alpha helps to determine the real performance of the portfolio.
Answer to Problem 1PS
A positive alpha can be associated with inferior performance of a portfolio if the Sharpe ratio has decreased.
Explanation of Solution
A positive alpha shows the performance of the portfolio relative to its benchmark while the Sharpe ratio shows the real return on each unit of investment. Thus it might be that the alpha is positive but Sharpe ratio has declined. This will in turn reflect inferior performance of the investment.
Therefore, yes it is true that a positive alpha may reflect inferior performance of the investment
Want to see more full solutions like this?
Chapter 18 Solutions
Connect 1-Semester Access Card for Essentials of Investments
- The Fortune Company is considering a new investment. Financial projections for the investment are tabulated below. The corporate tax rate is 24 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project. Year 0 Year 1 Year 2 Year 3 Year 4 Investment $ 28,000 Sales revenue $ 14,500 $ 15,000 $ 15,500 $ 12,500 Operating costs 3,100 3,200 3,300 2,500 Depreciation 7,000 7,000 7,000 7,000 Net working capital spending 340 390 440 340 ?arrow_forwardWhat are the six types of alternative case study compositional structures (formats)used for research purposes, such as: 1. Linear-Analytical, 2. Comparative, 3. Chronological, 4. Theory Building, 5. Suspense and 6. Unsequenced. Please explainarrow_forwardFor an operating lease, substantially all the risks and rewards of ownership remain with the _________. QuestFor an operating lease, substantially all the risks and rewards of ownership remain with the _________: A) Tenant b) Lessee lessor none of the above tenant lessee lessor none of the aboveLeasing allows the _________ to acquire the use of a needed asset without having to make the large up-front payment that purchase agreements require Question 4 options: lessor lessee landlord none of the abovearrow_forward
- How has AirBnb negatively affected the US and global economy? How has Airbnb negatively affected the real estate market? How has Airbnb negatively affected homeowners and renters market? What happened to Airbnb in the Tax Dispute in Italy?arrow_forwardHow has AirBnb positively affected the US and global economy? How has Airbnb positively affected the real estate market? How has Airbnb positively affected homeowners and renters market?arrow_forwardD. (1) Consider the following cash inflows of a financial product. Given that the market interest rate is 12%, what price would you pay for these cash flows? Year 0 1 2 3 4 Cash Flow 160 170 180 230arrow_forward
- Explain why financial institutions generally engage in foreign exchange tradingactivities. Provide specific purposes or motivations behind such activities.arrow_forwardA. In 2008, during the global financial crisis, Lehman Brothers, one of the largest investment banks, collapsed and defaulted on its corporate bonds, causing significant losses for bondholders. This event highlighted several risks that investors in corporate bonds might face. What are the key risks an investor would encounter when investing in corporate bonds? Explain these risks with examples or academic references. [15 Marks]arrow_forwardTwo companies, Blue Plc and Yellow Plc, have bonds yielding 4% and 5.3%respectively. Blue Plc has a credit rating of AA, while Yellow Plc holds a BB rating. If youwere a risk-averse investor, which bond would you choose? Explain your reasoning withacademic references.arrow_forward
- B. Using the probabilities and returns listed below, calculate the expected return and standard deviation for Sparrow Plc and Hawk Plc, then justify which company a risk- averse investor might choose. Firm Sparrow Plc Hawk Plc Outcome Probability Return 1 50% 8% 2 50% 22% 1 30% 15% 2 70% 20%arrow_forward(2) Why are long-term bonds more susceptible to interest rate risk than short-term bonds? Provide examples to explain. [10 Marks]arrow_forwardDon't used Ai solutionarrow_forward
Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education