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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.
A fund with a negative alpha _______.
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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.
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.
4.
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.
5.
A fund's alpha is dependent on the legitimacy of its beta measurement.
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True. After all, it measures performance relative to beta.