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

A portfolio earned 17% with a standard deviation of 20%. The risk-free rate is 6%, the market return is 13% and the market standard deviation is 14%. Using the M-squared (Modigliani) measure, by how much does the risk-adjusted portfolio outperform the market?

M-squared is 0.70%. Mixing 70% of the portfolio with 30% risk-free asset matches the market's 14% standard deviation, giving a return of 0.7 x 17% + 0.3 x 6% = 13.7%. This exceeds the market's 13% by 0.70 percentage points.

  1. A4.00%
  2. B0.05%
  3. C1.40%
  4. D0.70%Correct

Explanation

Scale the portfolio to market risk: weight in portfolio = 14/20 = 0.7, with 0.3 in the risk-free asset. Adjusted return = 0.7 x 17 + 0.3 x 6 = 13.7%. M-squared = 13.7 - 13 = 0.70%. Cross-check: Sharpe of portfolio = 11/20 = 0.55, market = 7/14 = 0.50, difference 0.05 x 14 = 0.70%. The 4.00% figure is the raw return difference, which ignores risk.

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