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1.
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.
2.
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.
3.
A fund's alpha is dependent on the legitimacy of its beta measurement.
True. After all, it measures performance relative to beta.
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.
The Sharpe ratio uses _______ to measure a fund's risk-adjusted returns.
Standard deviation. Because it uses standard deviation, the Sharpe ratio can be used to compare risk-adjusted returns across all fund categories.
