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Funds 205: Gauging Risk and Return Together: Alpha and the Sharpe Ratio

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1.
The higher a fund's Sharpe ratio, _______.
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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.
Which measurement is most useful to investors?
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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.
3.
Standard deviation lets us use the Sharpe ratio to compare risk-adjusted returns of funds in different categories.
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True. Standard deviation is calculated the exact same way for any type of fund, be it stock or bond.
4.
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?
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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.
5.
A high alpha for a fund proves good management skill on the part of the fund's management.
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False. Alpha cannot prove such skill, though it can be interpreted that way.