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1.
The higher a fund's Sharpe ratio, _______.
The greater its returns given the amount of risk it's taking on. The Sharpe ratio is based on the relationship between a fund's risk as measured by standard deviation and its returns.
2.
Alpha _______ distinguish between underperformance caused by incompetence and underperformance caused by fees.
Does not. Alpha does not distinguish between these two.
3.
A fund with a negative alpha _______.
Has returned less than you'd expect, given its beta. Alpha hinges on beta, not standard deviation. Funds with positive alphas have returned more than their betas suggested they would return.
4.
Which measurement is most useful to investors?
A Sharpe ratio of 1.7 for a fund with a standard deviation of 12%. Alphas aren't meaningful unless the fund's R-squared is greater than 75. Sharpe ratios, meanwhile, are always useful, because they involve standard deviations rather than betas.
5.
Funds A, B, and C each return 15%, while the SP 500 returns 10%. Relative to the SP 500, which fund has the highest alpha?
Fund C, which has a beta of 0.8. With its beta, you'd expect Fund C to gain 8% (10% x 0.8 = 8%). It made almost twice that. Fund A should have gained 10%, so it earns a lower alpha than Fund C. Fund B should have returned 17%, so the fund has a negative alpha.
