Concept Checker Answers

1. A Low diversification can produce this result because it will likely increase the standard deviation of the portfolio's returns, thus decreasing its Sharpe ratio. Using margin is not directly related to the risk-adjusted performance because adjusting for risk removes the effect of leverage. A Treynor ratio greater than the market Treynor ratio would result in a positive alpha (not a negative alpha).

2. C Beta is the "quantity of risk," and the market risk premium [E(Rp) - Rp] is the "price of risk." The product [E(Rp) — RpJ x (3 is the risk premium of an asset. The information ratio is not directly associated with the CAPM.

3. B The CAPM assumes that investors all hold the market portfolio because they all have the same expectations. This implies that they all have the same information, and there is no • private information that influences the asset prices.

4. C The Sharpe measure is the portfolio return minus the risk-free rate divided by the standard deviation of the return. The Treynor and Jensen measures use beta. The answer "beta measure" is a nonsensical choice for this question.

5. A The alpha is 9% - [3% + 0.8 x (12% - 3%)] = -1.2%.

The following is a review of the Risk Management and Investment Management principles designed to address the AIM statements set forth by GARP®. This topic is also covered in:

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