Discuss the M² Measure of Performance by Answering the Following

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Examlex · Accepted Answer

The Answer is The Sharpe measure indicates whether a portfolio underperformed the market index, but the difference between the market's Sharpe measure and the portfolio's Sharpe measure is difficult to interpret.M² uses the same measure of risk as the Sharpe measure-variation in total return, calculated as the standard deviation.For managed portfolio P an adjusted portfolio P* is formed by combining P with borrowing or lending at the risk-free rate to the point where P* has the same volatility as a market index (M).Then since M and P have the same standard deviation they can be directly compared using the M² measure.M² = r_P* - r_M.If P* outperforms M the measure will be positive, which means the CAL on which P* lies will have a steeper slope than the CML on which M lies.M² is the distance between the CAL and the CML.
The graph should look like the one in Figure 24.2.
Feedback: This question tests whether the student understands the characteristics and the construction of the M² measure.

Discuss the M2 Measure of Performance by Answering the Following

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Discuss the M² Measure of Performance by Answering the Following