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

A portfolio earned 18% with a standard deviation of 20%. The risk-free rate is 6%, the market portfolio returned 13% and its standard deviation was 15%. What is the M-squared (Modigliani) measure of the portfolio's performance relative to the market?

M-squared is +2.0%. The portfolio's Sharpe ratio is 0.6, so at the market's 15% risk it would earn 6% + 0.6 x 15% = 15%. This exceeds the market return of 13% by 2 percentage points. The raw 5% gap overlooks the higher risk taken.

  1. A+2.0%Correct
  2. B+5.0%
  3. C+15.0%
  4. D-2.0%

Explanation

Sharpe ratio = (18 - 6)/20 = 0.6. Adjusting the portfolio to the market's risk of 15% gives a return of 6 + 0.6 x 15 = 15%. M-squared = 15 - 13 = +2.0%. The value +5.0% is the raw return difference, 18 - 13, which ignores the risk difference. The value +15.0% is the risk-matched return and not the difference from the market. The value -2.0% has the wrong sign.

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