Free CFA Level III: Portfolio Management Performance Measurement Practice Questions

A is correct. The appraisal ratio is calculated as the portfolio's alpha (the return earned beyond what is explained by systematic risk exposure) divided by the portfolio's unsystematic (residual or idiosyncratic) risk. It measures the manager's ability to generate abnormal returns per unit of diversifiable risk taken.

B is incorrect because the total return divided by total volatility describes a variant of the return-to-volatility ratio. The Sharpe ratio uses excess return (over the risk-free rate) divided by total standard deviation.

C is incorrect because the excess return over the risk-free rate divided by beta describes the Treynor ratio, which measures risk-adjusted performance per unit of systematic risk, not the appraisal ratio.

C is correct. Transactions-based attribution incorporates actual trade data (purchases and sales with their dates and prices) in addition to beginning and ending holdings. This allows the attribution model to capture the return impact of intra-period trades, which holdings-based attribution — relying only on beginning-of-period or end-of-period snapshots — may miss. The result is a smaller residual (unexplained) component in the attribution.

Choice A is incorrect because transactions-based attribution requires more data (all trade records), not less. It is more complex and more costly to implement than holdings-based attribution because of the additional data requirements for recording every purchase and sale with precise dates and prices.

Choice B is incorrect because all relative attribution approaches, whether returns-based, holdings-based, or transactions-based, require benchmark return data to decompose the active return. The benchmark is the reference point against which sources of excess return are measured, regardless of the attribution methodology used.

A is correct. The Sortino ratio uses downside deviation in the denominator while the Sharpe ratio uses total standard deviation. When the Sortino ratio exceeds the Sharpe ratio, it indicates that downside deviation is less than total standard deviation (assuming the same numerator, which differs slightly by MAR vs. risk-free rate). This occurs when returns are positively skewed — there is more upside variation than downside variation, meaning the total standard deviation captures upside volatility that is not penalized by the Sortino ratio.

B is incorrect because if the distribution were negatively skewed (more downside variation), the downside deviation would be relatively larger, making the Sortino ratio lower than (or closer to) the Sharpe ratio, not higher.

C is incorrect because the Sortino and Sharpe ratios measure different things and commonly differ. The Sharpe ratio uses total standard deviation (both upside and downside) while the Sortino ratio uses only downside deviation. They will be equal only when the return distribution is perfectly symmetric around the MAR/risk-free rate.