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

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A fund with a negative alpha _______.

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.

A high alpha for a fund proves good management skill on the part of the fund's management.

True

False

False. Alpha cannot prove such skill, though it can be interpreted that way.

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

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.

What is alpha?

The difference between a fund's expected returns based on its beta and its actual returns

The degree to which a fund's returns move up or down given a gain or loss of its benchmark

The ratio of price to earnings

The difference between a fund's expected returns based on its beta and its actual returns.

If a fund returned 30% with a standard deviation of 15%, and the 90-day Treasury bill returned 3%, what's the fund's Sharpe ratio?

1.8

2.0

2.2

1.8. To calculate Sharpe ratio, subtract the T-bill return from the fund's return, and divide by standard deviation.