Test your knowledge

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The Sharpe ratio uses _______ to measure a fund's risk-adjusted returns.

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Beta

Standard deviation

Alpha

Standard deviation. Because it uses standard deviation, the Sharpe ratio can be used to compare risk-adjusted returns across all fund categories.

Alpha _______ distinguish between underperformance caused by incompetence and underperformance caused by fees.

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Does

Does not

Usually does

Does not. Alpha does not distinguish between these two.

A fund's alpha is dependent on the legitimacy of its beta measurement.

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True

False

True. After all, it measures performance relative to beta.

What allows us to use the Sharpe ratio to compare risk-adjusted returns of funds in different categories?

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Its use of standard deviation

Its use of beta

Both of the above

Neither of the above

Its use of standard deviation. Standard deviation is calculated the exact same way for any type of fund, be it stock or bond.

A fund with a negative alpha _______.

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Has returned more than you'd expect, given its beta

Has returned less than you'd expect, given its beta

Has returned less than you'd expect, given its standard deviation

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.

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