8/3/2019 Performance Evaluation by Ramesh
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Portfolio Management
Performance Evaluation
Presented By
T.Ramalingeswararao
Submitted To
Dr.D.H. Malini
Asst. Prof
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Introductionx Performance evaluation is a critical aspect
of portfolio management
x Proper performance evaluation should
involve a recognition of both the return and
the riskiness of the investment
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Performance Evaluation With
Cash Deposits & Withdrawals
x
Daily valuation methodx Modified Bank Administration Institute
(BAI) Method
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Daily Valuation Methodx The daily valuation method :
• Calculates the exact time-weighted rate of return
• Is bulky because it requires determining a valuefor the portfolio each time any cash flow occurs
– Might be interest, dividends, or additions and
withdrawals
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Daily Valuation
Method (cont’d)x The daily valuation method solves for R:
daily
1
1
where
n
i
i
i
i
R S
MVE
S MVB
=
= −
=
∏
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Daily Valuation
Method (cont’d)x MVE
i= market value of the portfolio at the end of
period i before any cash flows in period i but
including accrued income for the period
x MVBi= market value of the portfolio at the
beginning of period i including any cash flows at
the end of the previous sub period and including
accrued income
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Modified BAI Methodx The modified BAI method :
• Approximates the internal rate of return for the
investment over the period in question
• Can be complicated with a large portfolio that
might conceivably have a cash flow every day
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Modified BAI Method (cont’d)x It solves for R:
1
0
(1 )
where the sum of the cash flows during the period
market value at the end of the period,
including accrued income
market value at the start of the period
to
i
n
w
i
i
i
i
MVE F R
F
MVE
F
CD DwCD
CD
=
= +
=
=
=
−=
=
∑
tal number of days in the period
number of days since the beginning of the period
in which the cash flow occurred
i D =
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Performance Evaluation
When Options Are Used
x Incremental risk-adjusted return from
optionsx Residual option spread
x Final comments on performance evaluation
with options
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Definitionx The incremental risk-adjusted return
(IRAR) is a single performance measure
indicating the contribution of an options program to overall portfolio performance
• A positive IRAR indicates above-average
performance• A negative IRAR indicates the portfolio would
have performed better without options
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x The IRAR calculation:
( )
where Sharpe measure of the optioned portfolio
Sharpe measure of the unoptioned portfoliostandard deviation of the optioned portfolio
o u o
o
u
o
IRAR SH SH
SH
SH
σ
σ
= −
=
=
=
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An IRAR Examplex A portfolio manager routinely writes index
call options to take advantage of anticipated
market movementsx Assume:
• The portfolio has an initial value of $200,000
• The stock portfolio has a beta of 1.0• The premiums received from option writing are
invested into more shares of stock
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IRAR Caveatsx IRAR can be used inappropriately if there is
a floor on the return of the optioned
portfolio• E.g., a portfolio manager might use puts to
protect against a large fall in stock price
x
The standard deviation of the optioned portfolio is probably a poor measure of risk
in these cases
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Residual Option Spreadx The residual option spread (ROS) is an alternative
performance measure for portfolios containing
optionsx A positive ROS indicates the use of options
resulted in more terminal wealth than only holding
stock
x A positive ROS does not necessarily mean that theincremental return is appropriate given the risk
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Residual Option
Spread (cont’d)x The residual option spread (ROS)
calculation:
1 1
1where /
value of portfolio in Period
n n
ot ut
t t
t t t
t
ROS G G
G V V
V t
= =
−
= −
=
=
∏ ∏
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Final Commentsx IRAR and ROS both focus on whether an
optioned portfolio outperforms an
unoptioned portfolio• Can overlook subjective considerations such as
portfolio insurance
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THANK UUUUUUUUUUUUU
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