Amnec Reading

[JalilaZ]

Hi David,

One note on Page 8, the assumptions given are different than the snapshot of the spread sheet : RF 7% while in those calculated it is 4% same for market return5.18% vs 10%, portfolio return 16% vs 14%

now the question on the calculation of the Information ratio, what i understood from the study notes is that it should be consistent, how did we reach to the formula of alpha/TE , reference to the notes it is alpha/(stdv alpha)
reference to the reading, i used the formula of active return over TE and I got (14%-4$/3%) =3.3 - please clarify

Thanks,
Jalila

 

[JalilaZ]

1- Another Question on the post reading questions (lecture notes), question number 1, part (e)
"What is the function that characterizes the CML here, in slope-intercept form?

part of the answer:

E(portfolio return) = 4% + (% invested in market portfolio)*12% "


from where did we get the 12% ? if it is the return on the market it should be 15% as per the question



2- Question number 5, i found nothing in the lecture notes that speak about this ? what's the logic behind the answer ?

 

[tosuhn]

Hihi @Nicole Manley & @David Harper CFA FRM CIPM , I am not sure how the slope-intercept form is derived for E(portfolio return) = 4% +(% invested in market portfolio)*12%.
Hope to hear from you soon!

 

[Alex_1]

Hi, with regard to the question 1, part e, I think it should be 12.8% and not 12% as the CML equation is Exp. portfolio return = risk-free rate + (Sharpe ratio * portfolio volatility) and the volatility as per the question is given as 12.8%.
@tosuhn, if you wish to understand the derivation of th Capital Market Line (CML) I recommend taking a closer look at the Elton notes (also from T1. Foundations of Risk - https://learn.bionicturtle.com/frm-...erials/study-notes-elton-gruber-chapters-5-13).
@JalilaZ: question number 5 is inspired (I believe) from the Elton notes, specifically on page number 9 the STRONG-FORM of efficient market hypothesis (EMH) is mentioned.

I hope that helps.

 

[David Harper CFA FRM]

@JalilaZ

There is a mistake at the top of page 8: the spreadsheet is correct such that the text above should match with

• Risk free rate = 4.0%
• Excess Market return = 10.0%

Sorry for the confusion. We will fix this.

Re: I/R, yes, you are fine to do that per the text below the chart (the Amen assignment creates this confusion, frankly):

As noted, the information ratio can be variously defined. This example follows Amenc’s (the assigned author) with IR = residual return/residual risk. It would not be wrong to use active return/active risk.

Your approach is fine, although notice that you assume active is return over the risk-free rate; return over the risk-free rate is firstly called excess return. I do realize alpha/TE is confusing, per our feedback to GARP that it implies residual risk /active return which is ratio-inconsistent but that's because TE is defined differently by different authors.

@tosuhn Re: E(portfolio return) = 4% + (% invested in market portfolio)*12%
I think it's my mistake. I need to bookmark and refer to @Alex_1 helpful reference but this looks wrong and currently I cannot figure out what I was thinking to add this line; for example, 100% allocated to market portfolio would give R = 4% + 12.8%, which looks wrong. Even R = 4% riskfree + (% to market)*(12.8%-4%) looks like it has problems, too, even after correcting 12.8%. My original answer looks fine, I'm not sure why I tried to supplement it with another answer, uggh ... the original answer--i.e., E(portfolio return) = 4% + 0.86*volatility(portfolio)--is really best because it reflects the x-axis of CML as volatility (versus beta in SML). Apologies for the confusion.

#revisepdf

 

[tosuhn]

Hi, with regard to the question 1, part e, I think it should be 12.8% and not 12% as the CML equation is Exp. portfolio return = risk-free rate + (Sharpe ratio * portfolio volatility) and the volatility as per the question is given as 12.8%.
@tosuhn, if you wish to understand the derivation of th Capital Market Line (CML) I recommend taking a closer look at the Elton notes (also from T1. Foundations of Risk - https://learn.bionicturtle.com/frm-...erials/study-notes-elton-gruber-chapters-5-13).
@JalilaZ: question number 5 is inspired (I believe) from the Elton notes, specifically on page number 9 the STRONG-FORM of efficient market hypothesis (EMH) is mentioned.

I hope that helps.

thanks @Alex_1

 

[tosuhn]

h

@JalilaZ

There is a mistake at the top of page 8: the spreadsheet is correct such that the text above should match with

• Risk free rate = 4.0%
• Excess Market return = 10.0%

Sorry for the confusion. We will fix this.

Re: I/R, yes, you are fine to do that per the text below the chart (the Amen assignment creates this confusion, frankly):

Your approach is fine, although notice that you assume active is return over the risk-free rate; return over the risk-free rate is firstly called excess return. I do realize alpha/TE is confusing, per our feedback to GARP that it implies residual risk /active return which is ratio-inconsistent but that's because TE is defined differently by different authors.

@tosuhn Re: E(portfolio return) = 4% + (% invested in market portfolio)*12%
I think it's my mistake. I need to bookmark and refer to @Alex_1 helpful reference but this looks wrong and currently I cannot figure out what I was thinking to add this line; for example, 100% allocated to market portfolio would give R = 4% + 12.8%, which looks wrong. Even R = 4% riskfree + (% to market)*(12.8%-4%) looks like it has problems, too, even after correcting 12.8%. My original answer looks fine, I'm not sure why I tried to supplement it with another answer, uggh ... the original answer--i.e., E(portfolio return) = 4% + 0.86*volatility(portfolio)--is really best because it reflects the x-axis of CML as volatility (versus beta in SML). Apologies for the confusion.

#revisepdf

hi @David Harper CFA FRM CIPM thanks for your reply

 

[JalilaZ]

Thank you David that was helpful
so what I understand is that the below formula is wrong

E(portfolio return) = Rf + (% invested in market portfolio)*volatility "

and the accurate formula is E= RF + Sharpe* volatility

As for the IR, it seems that it is ok to be ratio inconsistent in the exam ? i.e I can use residual over active ?

@Alex_1 Thanks Alex - means that even if you have private info, market will adjust rapidly

 

[David Harper CFA FRM]

Hi @JalilaZ

• Re: CML: yes, the first is wrong and, for CML the correct is E(r)= RF + Sharpe* volatility, which reflects its "y = mx + b" nature with volatility as the x-axis and the Sharpe ratio as the slope (see http://en.wikipedia.org/wiki/Capital_market_line). This is how I think of the key difference between CML and SML: CML has volatility as x axis (versus beta for SML); and CML line is all efficient portfolios (same Sharpe ratio, and slope of CML is Sharpe), while SML does not assume efficient portfolios
• Re: IR: No, please do not use inconsistent. We have confirmed with GARP (and the notes should reflect this twice) you should be ratio consistent, either: (active risk)/(active return) or (residual risk)/(residual risk). Put simply, the denominator is the volatility of the numerator metric!

The issue is that some of these definitions are variously unsettled (unfortunately). However,

• alpha = residual (no doubt, imo)
• active = excess (in the GARP historical record, so I think no doubt here either)
• tracking error really tends to refer to active risk (i.e., standard devation of active return) but it suffers some definitional differences. Thanks,

 

[Dr. Jayanthi Sankaran]

Hi David,

Just a small observation - in page 8 of the Amenc Study Notes, would it not be more accurate to express the Treynor Ratio and Jensen's alpha in percentages, to differentiate them from the Sharpe ratio and the information Ratio, which have no units? Just a thought!

 

[Dr. Jayanthi Sankaran]

Hi @JalilaZ,

1- Another Question on the post reading questions (lecture notes), question number 1, part (e)
"What is the function that characterizes the CML here, in slope-intercept form?

part of the answer:

E(portfolio return) = 4% + (% invested in market portfolio)*12% "


from where did we get the 12% ? if it is the return on the market it should be 15% as per the question


Not only that, the answer should be:

E(portfolio return) = (% invested in risk-free asset)*4% + (% invested in market portfolio)*15% "

 

[Dr. Jayanthi Sankaran]

Hi @Alex_1,

Hi, with regard to the question 1, part e, I think it should be 12.8% and not 12% as the CML equation is Exp. portfolio return = risk-free rate + (Sharpe ratio * portfolio volatility) and the volatility as per the question is given as 12.8%.

The CML equation is Expected Portfolio Return = Risk-free rate + (Sharpe Ratio)*Portfolio volatility

The Portfolio volatility is not 12.8% - if you read carefully, volatility of the Market Return = 12.8%. The Portfolio volatility as calculated from (1) c is 6.4%

Hence, according to the CML:

Expected Return of Portfolio = 4% + 0.86*(6.4%) = 9.5% (consistent with David's answer in (1) c, page 11)

 

[ShaktiRathore]

Hi,
CML IS, E(portfolio return) = 4% + SharpeRatio of mkt port.*std dev of port.
E(portfolio return) = 4% + ((Exp mkt. return-4%)/std dev mkt)*std dev of port.
E(portfolio return)=4%+ ((Exp mkt. return-4%)/std dev mkt)*std dev of mkt*weight in mkt port.
E (portfolio return)=4%+ ((Exp mkt. return-4%)*weight in mkt port.
12% is nothing but Exp mkt. return-4%.
Thanks

 

[Dr. Jayanthi Sankaran]

Hi Shakti,

Neat derivation - however, the Expected market return as per the data given is 15% and so does not give 12% for (Expected Market Return - 4%).

Thanks!