Question

Investment companies and performance evaluation

1) Consider two different hedge funds with the following data related to performance:

Hedge fund Alpha Beta

Fund A   5% 1.6

Fund B   3% 0.8

Assuming that beta is consistent with the type of investing we expected in both cases, which fund performed better.
A. Fund A, because it had the higher return
B. Fund A, because it had the higher alpha
C. Fund B, because its alpha is more impressive than Fund A when we consider how much less risk the fund took.
D. Fund B, because the beta is closer to 1.

2) When we analyze the performance of an actively managed mutual fund we find that the fund generated a beta of 1 and an alpha of zero.

A. this result shows that the manager took no risk when investing

B. this result shows that the manager did not add any value to performance with his/her decision-making

C. both (A) and (B) are true

D. none of the above

3) Consider two different hedge funds with the following data related to performance:

Hedge fund Alpha Beta

Fund A   1% 0.8

Fund B   3% -0.3
Assuming that beta is consistent with the type of investing we expected in both cases, which fund performed better?

A. Fund A, because Fund B should have negative alpha to match its negative beta
B. Fund A, because it had a higher beta than Fund B
C. Fund B, because its alpha is higher than Fund A.
D. Fund A, because the beta is closer to 1.

4) A positive alpha for a mutual fund means:

A. the fund invested in high-risk strategies

B. the fund manager’s performance was bad

C. both (A) and (B)

D. none of the above

Answer 1

ANSWERS

QUESTION 1 : OPTION C

EXPLANATION:

Alpha indicates excess return over and above the market return. Even though Fund A has an Alpha of 5% . It has a Beta of 1.6 which indicates a higher volatility(more fluctuation than the market). On the other hand  Fund B -has an alpha of 3% With a Beta Of 0.8 which indicates a lower volatility. Hence Fund B is preferred over A.

QUESTION 2: OPTION B

EXPLANATION:

Alpha of 0 indicates that the portfolio or fund is in track with the benchmark index or market return and that there is nothing that the Manager has earned or lost compared to the market return. Alpha is basically the excess return earned by a fund which is over and above the market return (In short out performance of return is indicated by alpha)

QUESTION 3: OPTION D

EXPLANATION:

Fund A has a Beta closer to 1 (0.8) and it indicates that it is less volatile than the market with a decent Alpha 1%. On the other hand Fund B has a negative Beta -0.3 which indicates that the fund moves in the opposite direction of the market. Though negative beta protects the investor against serious market declines, It also has some limitations also, most importantly losing on opportunities to make profits when the market is positive. Hence negative beta is not recommended.

QUESTION 4: OPTION D

EXPLANATION:

A Positive Alpha means that a fund manager managing a mutual fund managed to get a return over and above what one would normally get with a given risk indicated by Beta. In short, It indicates the efficiency of a fund manager in managing the fund and in generating a return higher than the market.