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

A portfolio has return 18% and standard deviation 20%. The market index has return 14% and standard deviation 15%. The risk-free rate is 6%. Using the M-squared (Modigliani) measure, what is the risk-adjusted performance relative to the market?

M-squared is 1.0%. Mixing 75% of the portfolio with 25% risk-free matches the market's 15% standard deviation and gives a 15% return. That is 1 percentage point above the market's 14%, so the portfolio outperforms on a risk-adjusted basis.

  1. A1.0%Correct
  2. B4.0%
  3. C8.0%
  4. D2.0%

Explanation

Scale the portfolio to market risk: weight = 15/20 = 0.75 in the portfolio and 0.25 in risk-free. Adjusted return = 0.75 x 18 + 0.25 x 6 = 15%. M-squared = 15 - 14 = 1.0%. The 4.0% option is the raw return difference. The 8.0% option inverts the weight (20/15) and leverages the portfolio.

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