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CMA Final · Strategic Financial Management · Portfolio Performance Evaluation and Portfolio Revision

A fund earned 18% with a standard deviation of 20%. The market index earned 14% with a standard deviation of 16%, and the risk-free rate is 6%. Using the Modigliani (M-squared) measure, what is the fund's risk-adjusted performance relative to the market?

M-squared adjusts the fund to the market's risk level and compares returns. The fund's Sharpe ratio is 0.6, so at 16% risk it would earn 6% + 0.6 × 16% = 15.6%. Against the market's 14%, M-squared is +1.6%.

  1. A+1.6%Correct
  2. B+4.0%
  3. C+15.6%
  4. D+0.10%

Explanation

Fund Sharpe ratio = (18 − 6)/20 = 0.6. Leveraged down to the market's 16% risk, the fund's return is 6 + 0.6 × 16 = 15.6%. M-squared = 15.6 − 14 = +1.6%. +4.0% is the raw return difference. +15.6% is the adjusted return and not the difference. +0.10 is the Sharpe ratio gap (0.6 − 0.5), which is not in percentage return terms.

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