Quick Answer
Current yield is annual income over current price. Total return adds capital change plus income over beginning value. Time-weighted return judges the manager and ignores cash flows; dollar-weighted return judges the investor. Sharpe uses total risk, Treynor uses systematic risk, and a benchmark must match the portfolio's style, cap size, and geography.
The whole unit on one sheet: current yield, every return measure, the risk-adjusted ratios, and picking the right benchmark.
Which One-Liners Win Points?
- Current yield and price move inversely: the coupon is fixed, so a higher price means a lower yield.
- Annualized return uses geometric (compound) averaging, not arithmetic; arithmetic generally overstates true compound growth whenever periodic returns vary.
- Positive alpha means the manager beat what the Capital Asset Pricing Model (CAPM) predicted, not just that the portfolio rose.
Which Formulas Must You Reproduce?
Current yield, bonds:
Current yield, stocks:
- Total return / holding period return (HPR): (Ending Value minus Beginning Value, plus Income) / Beginning Value
- Expected return: Sum of (Probability x Return) for each scenario
- Sharpe ratio: (Portfolio Return minus Risk-Free Rate) / Standard Deviation of Portfolio
- Treynor ratio: (Portfolio Return minus Risk-Free Rate) / Beta of Portfolio
- Jensen's alpha: Portfolio Return - [Risk-Free Rate + Beta x (Market Return - Risk-Free Rate)]
- Real (inflation-adjusted) return, approximate: Nominal Return minus Inflation Rate
- Real return, precise: (1 + Nominal) / (1 + Inflation) - 1
- Tax-equivalent yield: Municipal Bond Yield / (1 - Tax Rate)
Which Worked Examples Should You Recognize?
- Total return: buy at $50, collect $2 dividend, sell at $55. ($55 - $50 + $2) / $50 = 14%.
- Expected return: (0.40 x 12%) + (0.50 x 6%) + (0.10 x -8%) = 4.8% + 3.0% + (-0.8%) = 7.0%.
- Real return: 8% nominal, 3% inflation. Approximate = 5%; precise = (1.08 / 1.03) - 1 = 4.85%.
- Tax-equivalent yield: 3.5% muni, 32% federal bracket. 3.5% / (1 - 0.32) = 3.5% / 0.68 = 5.15%.
How Do Price, Coupon, and Yield Move Together?
| Bond Price vs. Par | Current Yield vs. Coupon | Current Yield vs. YTM |
|---|---|---|
| Premium (above par) | Current yield < coupon | Current yield > YTM |
| At par | Current yield = coupon | Current yield = YTM |
| Discount (below par) | Current yield > coupon | Current yield < YTM |
Which Return Measure Applies When?
| Measure | What It Shows | Cash Flows | Best Used For |
|---|---|---|---|
| Time-weighted | Manager's skill | Removed | Evaluating the manager, GIPS reporting |
| Dollar-weighted (commonly the IRR) | Investor's experience | Included | Evaluating the investor's actual result |
| Sharpe ratio | Excess return per unit of total risk | Uses standard deviation | The investor's entire portfolio |
| Treynor ratio | Excess return per unit of systematic risk | Uses beta | One of many diversified portfolios |
| Alpha | Return above CAPM prediction | Uses beta via CAPM | Any actively managed portfolio |
What Makes a Benchmark Relevant?
| Benchmark | What It Tracks |
|---|---|
| S&P 500 | 500 large-cap U.S. equities |
| Russell 2000 | Small-cap U.S. equities |
| MSCI EAFE (Europe, Australasia, Far East) | International developed markets (excludes U.S. and Canada) |
| Bloomberg U.S. Aggregate Bond Index | Investment-grade, dollar-denominated, fixed-rate taxable U.S. bonds |
| MSCI Emerging Markets | Emerging market equities |
- Match style (value vs. growth), cap size, geography, and asset class to the portfolio.
- Multi-asset portfolios may use a custom blended benchmark (e.g., 60% S&P 500 + 40% Bloomberg Aggregate) or a published multi-asset index.
Which Gotchas Trip Students Up?
- HPR and total return share one formula, but HPR is not annualized: a 30% HPR over 3 years is not a 10% annual return.
- If a well-diversified portfolio has no unsystematic risk left, Sharpe and Treynor rank managers the same; if it is not diversified, the rankings can diverge.
- A portfolio can post a positive return and still have negative alpha if it underperformed the CAPM expectation for its risk.
- GIPS generally requires time-weighted return (exception only when the firm controls external cash flows AND the fund is closed-end, fixed-life, fixed-commitment, or significantly illiquid); picking dollar-weighted for manager evaluation is the trap.
- MSCI EAFE excludes the U.S. and Canada; Russell 2000 (small-cap) is easily confused with the Russell 3000 (roughly 98% of the investable U.S. market by cap).
- Municipal bond interest is generally exempt from federal tax (and possibly state or local in-state), which is why the tax-equivalent yield grosses it up before comparing to a taxable bond.
One-Breath Recap
Current yield is annual income over current price and moves inversely to price, sitting below the coupon on a premium bond and above it on a discount bond, while total return and holding period return add price change plus income over beginning value. When the exam asks about the manager use time-weighted return (cash flows removed, generally required by GIPS); when it asks about the investor's own experience use dollar-weighted return, commonly the internal rate of return. Judge risk with Sharpe (total risk, standard deviation) for a whole portfolio and Treynor (systematic risk, beta) for one of many, and read positive alpha as beating the Capital Asset Pricing Model prediction rather than merely rising. Always benchmark against a matching style, cap size, and geography, because a small-cap fund measured against the S&P 500 evaluates nothing.
Need more than the recap? Read the full Portfolio Performance Measures unit.