CMA Final · Strategic Financial Management
Portfolio Performance Evaluation and Portfolio Revision for CMA Final
Portfolio performance evaluation checks whether a portfolio's return was good for the risk taken, using Sharpe, Treynor and Jensen's alpha. Portfolio revision changes the holdings as markets move, using judgement or formula plans. To solve questions, compute excess return over the risk-free rate, divide by the right risk measure, then rank and recommend.
What this chapter covers
This chapter answers two questions about a portfolio you already hold. First: how well did it do, after allowing for risk? Second: should you change it, and by what rule? The first part gives you three standard tools. Sharpe ratio and Treynor ratio give reward per unit of risk. Jensen's alpha gives the return earned above what the CAPM expects.
The second part deals with portfolio revision. You learn why a portfolio drifts away from its target, what it costs to rebalance, and how mechanical rules called formula plans remove emotion from the decision. These include the constant rupee value plan, the constant ratio plan and the variable ratio plan.
The chapter sits on top of earlier work in Paper 14. You need return, standard deviation, beta, CAPM and the Security Market Line from portfolio theory. If those are weak, this chapter will feel hard. If they are strong, most of it is short, repeatable calculation plus a clear recommendation.
This chapter is compact and calculation-driven, so it rewards practice more than reading. The same few formulas appear in MCQs, and a ranking question with three or four portfolios is a natural fit for a descriptive answer. The workings are short, and you can score full marks if your steps and your recommendation are clear. It also tests concepts you need elsewhere in the paper, such as CAPM, beta and risk-free return, so the effort here pays off twice.
Portfolio Performance Evaluation and Portfolio Revision: topics in the order to study them
- 1Portfolio Performance Evaluation: Meaning and NeedStart here to learn what is being measured and why raw return alone misleads, before any formula.
- 2Sharpe and Treynor Performance MeasuresThese are the core ratios; learn them next because both use excess return and differ only in the risk measure.
- 3Jensen's Alpha and Other Risk-Adjusted MeasuresAlpha builds on CAPM and the Treynor idea, so it comes after the two main ratios.
- 4Portfolio Revision: Meaning and NeedOnce you can judge a portfolio, you can see why and when it needs to be changed.
- 5Portfolio Revision Formula PlansStudy these last because they are the rule-based answer to the revision problem and need the concepts above.
How to prepare Portfolio Performance Evaluation and Portfolio Revision
Treat this as a formula-and-interpretation chapter. Aim for fast, accurate workings and a one-line conclusion every time.
- Refresh CAPM, beta, standard deviation and the Security Market Line from the earlier portfolio chapters before you begin.
- Read the meaning and need of evaluation, then write the Sharpe, Treynor and Jensen formulas from memory, noting which risk measure each uses.
- Solve at least five ranking problems. Compute each measure for every portfolio, rank them, and state which is best and why.
- Practise interpreting results. Ask when Sharpe and Treynor rankings differ and what that says about diversification.
- Learn the revision concepts in words, covering transaction costs, drift and timing, then work through each formula plan with a rising and falling market.
- Build a small table for the formula plans showing the trigger, the action and the behaviour in rising and falling markets, and revise it often.
- Finish with timed MCQs and one full descriptive question, ending each with a clear recommendation.
Common mistakes in Portfolio Performance Evaluation and Portfolio Revision
Forgetting to subtract the risk-free rate in Sharpe or Treynor.
Fix: Write the numerator as (Rp − Rf) first, every time, before touching the denominator.
Using standard deviation in Treynor or beta in Sharpe.
Fix: Link each to its risk: Sharpe with total risk (σ), Treynor with systematic risk (β).
Computing Jensen's alpha with the market return instead of the CAPM expected return.
Fix: Compute the CAPM return first, then subtract it from the actual return.
Stopping at the numbers without a conclusion.
Fix: End with a ranking and a recommendation, such as which portfolio to prefer and why.
Mixing up the formula plans or their triggers.
Fix: Practise each plan with a numerical example and a comparison table covering rising and falling markets.
Last-day revision: Portfolio Performance Evaluation and Portfolio Revision
- Sharpe ratio = (Rp − Rf) ÷ σp, using total risk.
- Treynor ratio = (Rp − Rf) ÷ βp, using systematic risk.
- Jensen's alpha = Rp − [Rf + βp × (Rm − Rf)].
- A positive alpha means the portfolio beat the return expected for its beta.
- Sharpe suits a whole portfolio; Treynor suits one portfolio among many held by a diversified investor.
- For a well-diversified portfolio, Sharpe and Treynor rankings tend to agree.
- Always subtract the risk-free rate from the portfolio return before dividing.
- Portfolio revision means changing holdings to keep the portfolio aligned with the investor's objectives.
- Constant rupee value plan keeps the value of the aggressive portfolio fixed and trades the difference.
- Constant ratio plan keeps a fixed ratio between aggressive and conservative portfolios.
- Formula plans need a trigger point and ignore forecasts.
- State your ranking and recommendation in words at the end.
Portfolio Performance Evaluation and Portfolio Revision practice questions
- A mutual fund's net asset value was Rs 50 at the start of the year. During the year it paid a dividend of Rs 2 and a capital gains distribut…
- An investor follows a constant ratio plan with a 50:50 split between equity and bonds, rebalancing after every market move. The initial port…
- An investor follows a constant ratio plan with a 50:50 split between equity and bonds and rebalances after every move. She starts with Rs 10…
- Portfolio P has a return of 16%, beta of 1.25 and standard deviation of 20%. The risk-free rate is 6%. What is the Treynor ratio of Portfoli…
- A portfolio manager at a Mumbai fund house reports an average annual return of 14% on a portfolio with a beta of 1.6. The risk-free rate is …
- An equity fund earned 14% in a year while its benchmark index returned 11%. The annualised tracking error (standard deviation of the active …
- A portfolio manager's fund returned 15% with a standard deviation of 20%. The risk-free rate is 6%, the market return is 12% and the market …
- A portfolio returned 11% against a benchmark return of 9%. The portfolio's tracking error is 4%. What is the information ratio?
Portfolio Performance Evaluation and Portfolio Revision in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
Portfolio Performance Evaluation and Portfolio Revision: frequently asked questions
What is the difference between Sharpe and Treynor ratios?
Both measure excess return per unit of risk. Sharpe divides by standard deviation, which is total risk. Treynor divides by beta, which is systematic risk only.
What does a positive Jensen's alpha mean?
It means the portfolio earned more than the CAPM return expected for its level of beta. It suggests the manager added value after allowing for systematic risk.
Why is portfolio revision needed?
Market prices change, so the mix of assets drifts from the investor's target. Objectives and circumstances can also change. Revision brings the portfolio back in line, after weighing transaction costs.
Are formula plans important for the exam?
They are part of the chapter, so expect conceptual MCQs and small numerical questions. Learn the rule of each plan and practise one example of each.