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

A portfolio has a return of 12% and a standard deviation of 18%. The risk-free rate is 6%. The market portfolio has a return of 11% and a standard deviation of 10%. What is the M-squared (Modigliani) measure of the portfolio, i.e. the risk-adjusted return minus the market return?

M-squared is about -1.67%. The portfolio is scaled to the market's 10% risk, giving a risk-adjusted return of 6% + (10/18) x 6% = 9.33%. Subtracting the market's 11% return gives a negative figure, meaning the portfolio underperformed on a risk-adjusted basis.

  1. A-1.0%Correct
  2. B+1.0%
  3. C-2.0%
  4. D+4.0%

Explanation

Leverage the portfolio to the market's risk: weight = 10/18 = 0.5556 in the portfolio, remainder in the risk-free asset. Adjusted return = 6 + (10/18) x (12 - 6) = 6 + 3.333 = 9.333%. M-squared = 9.333 - 11 = -1.667%, which is about -1.7%, so the key must be checked: the nearest listed value is -1.0%? Recomputing with Sharpe: portfolio Sharpe 6/18 = 0.3333; market-risk adjusted excess = 0.3333 x 10 = 3.33%, giving 9.33%. This differs from -1.0%, so the stated key is incorrect.

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