Chapter 17: Performance Measurement 2

Question 1

State the aim of portfolio risk and return analysis

List the steps in portfolio risk and return

Answer 1

Aim

• To assess whether superior performance has been obtained simply by taking more risk or by superior stock and sector selection and tiing

Steps

• Plot overall TWRR from portfolio over period against riskiness of portfolio
• Compare portfolio to bechmark/peer group/simulated portfolios
• Riskiness measured by looking at standard deviation of returns over historical sub periods or implied volatilities

Question 2

List three potential problems with portfolio risk and return analysis

Answer 2

• Creeping change portfolio compoisition - riskiness of portfolio may change gradually, but significantly, over time
• Successful investment manager ay be treated unfairly by measurement syste eg if skilled at selecting high risk stocks
• manager may disagree with market view of stok’s or market’s prospects and/or uncertainity attached to those prospects

Question 3

List three advantages and four disadvantages of assess the performance of a share using its market price

Answer 3

Advantages

• Objective
• Generally quick, cheap and easy to obtain
• Easy to understand/justify

Disadvantages

• Subject to short term fluctuations, so volatile
• need to allow for income
• unavailable for unquoted shares
• may be more than one quoted figure, eg bid price and offer price

Question 4

List three advantages and four disadvantages of assessing the performance of a share using its net present value

Answer 4

Advantages

• Can be made consistent with basis used to value liabilities
• useful for unquoted shares
• yields stable results

Disadvantages

• Depends on subjective assumptions
• results will reflect any changes in assumptions
• differs from actual market price, at which shares actually traded
• difficult to understand

Question 5

List three advantages and five disadvantages of assessing the performance of a share using its NAV per share

Answer 5

Advantages

• Yields stable results
• available for unquoted shares
• useful for investment and property companies

Disadvatages

• Based on accounting values, not true, economic values
• depends on subjective accounting standards
• results will reflect any changes in accounting standards
• may exclude intabibles/goodwill
• difficult to compare companies in different sectors

Question 6

State the formula used to calculate the risk adjusted return on capital (RAROC) for a company

How the return is estimated in the RAROC formula and explain what the formula tells you

Answer 6

The risk adjsuted return on capital calculated as

RAROC = R - ß(R_m - r_f)

Where R is return achieved by compnay, ß reflects systemic risk of irs projects, R_m is market return and r_f the risk free return of return

• Return as profits divided by capital employed to generate those profits
• If RAROC > r_f company has out performed after allowing for cost adn risk involved in using its cpaital to generate its profits

Question 7

Give three reasons why the risk adjusted return on capital (bbbRAROC)

Answer 7

• .Difficult to accutely estimate beta of the company
• Difficult to estimate company profits, as soem accounting costs (eg depreciation) need to be subjectively adjusted to reflect cost using the company’s assets
  
  • Also, costs not associated with using or maintaining existing capital should be excluded rom profit calculation
• Difficult to accuragely estimate capital employed within business to generate profits - in particular, vlaues of any intabgibles