Portfolio performance Evaluation - Security Analysis and Portfolio Management - Solved Quiz, Exercises for Investment Management and Portfolio Theory. Indian Institute of Technology (IIT)

Portfolio performance Evaluation - Security Analysis and Portfolio Management - Solved Quiz, Exercises for Investment Management and Portfolio Theory. Indian Institute of Technology (IIT)

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Course title for this quiz is Security Analysis and Portfolio Management. Instructors are Dr. Chandra Sekhar Mishra and Dr. Jitendra Mahakud. There is solved quiz related to every lecture they delivered at IIT Kharagpur....
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Course Name: Security Analysis and Portfolio Management

Department: VGSOM, IIT Kharagpur

Instructors: Dr. Chandra Sekhar Mishra & Dr. Jitendra Mahakud ___________________________________________________

Session 40: Portfolio performance Evaluation-II 1. Write short note on Bond Market Line Evaluation. Ans.

• Bond Market Line :a measure of risk such as beta coefficient for equities • Difficult to achieve due to bond maturity and coupon effect on volatility of

prices • Composite risk measure is the bond’s duration • Duration replaces beta as risk measure in a bond market line • The Bond Market Line differs from the SML in the selection of the measure of

risk (duration v. beta) and the selection of a proxy for the market index Bond Market Line Evaluation

• Policy effect: Difference in expected return due to portfolio duration target • Interest rate anticipation effect: Differentiated returns from changing duration of

the portfolio • Analysis effect: Acquiring temporarily mispriced bonds • Trading effect: Short-run changes

2. How to Analyze Sources of Return?

Ans. Step- 1: Decomposing Portfolio Returns:

• Total return during a period is the income effect and a price change effect • The yield-to-maturity (income) effect is the return an investor would receive if

nothing had happened to the yield curve during the period • Interest rate effect measures changes in the term structure of interest rates during

the period • The sector/quality effect measures expected impact on returns because of

changing yield spreads between bonds in different sectors and ratings • The residual effect is what is left after accounting for the first three factors • A large positive residual would indicate superior selection capabilities • Time-series plot demonstrates strengths and weaknesses of portfolio manager

Step-2: Analyzing Sources of Return:

• Total return (R) made up of the effect of the interest rate environment (I) and the contribution of the management process (C)

R = I + C


• I is the expected rate of return (E) on a portfolio of default-free securities and the unexpected return (U) on the Treasury Index

I = E + U

• C is composed of M = return from maturity management S = return from spread/quality management B = return attributable to the selection of specific securities R = I + C = (E + U) + (M + S + B)

3. How to undertake Portfolio Performance Evaluation of the Portfolio Manager? Ans. Portfolio Performance Evaluation of the Portfolio Manager can be broadly undertaken under the following aspects:

• Performance Attribution Analysis: Asset allocation Effect, Selection Effect • Manager Universe Comparison: style • Subjective Vs. Objective Comparison: Practical constraints • Comparison with Existing Benchmark • Choosing and Constructing the Benchmark: Objective and Strategy • Multicurrency Investment: Currency risk management • Balance Benchmark: Weighted average of all benchmarks

4. How to Compute Portfolio Returns?


• To evaluate portfolio performance, it is essential to measure it • Holding period yield, which equals the change in portfolio value plus income

divided by beginning portfolio value: Computing Portfolio Returns:

• Dollar-weighted rate of return (DWRR): Internal rate of return on the portfolio’s cash flows

• Time-weighted rate of return (TWRR): Geometric average return • TWRR is better: Considers actual period by period portfolio returns, No size

bias - inflows and outflows could affect results _________________________________________

( ) 1

Value Beginning

Value Ending HPY −=

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