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

A portfolio manager's fund returned 15% with a standard deviation of 20%. The risk-free rate is 6%, the market return is 12% and the market standard deviation is 15%. What is the fund's M-squared (Modigliani) measure of excess return over the market?

M-squared is 0.75%. The fund is scaled to the market's 15% risk by holding 75% in the fund and 25% in the risk-free asset, giving a return of 12.75%. Subtracting the market return of 12% leaves 0.75% as the risk-adjusted outperformance.

  1. A0.75%Correct
  2. B1.50%
  3. C3.00%
  4. D6.75%

Explanation

To match market risk of 15%, put 15/20 = 0.75 in the fund and 0.25 in the risk-free asset. Adjusted return = 0.75x15% + 0.25x6% = 12.75%. M-squared = 12.75% - 12% = 0.75%. Check: Sharpe = 9/20 = 0.45; 6 + 0.45x15 = 12.75%. Option 3.00% simply takes the raw return difference without adjusting risk.

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