Portfolio Performance Measures

The whole unit on one sheet: current yield, every return measure, the risk-adjusted ratios, and picking the right benchmark.

The One-Liners That Win Points

• Current yield measures income return only; it ignores capital gains, losses, and the pull to par at maturity.
• Current yield and price move inversely: the coupon is fixed, so a higher price means a lower yield.
• Time-weighted return evaluates the manager (strips out client cash flows); dollar-weighted return evaluates the investor (reflects timing of deposits and withdrawals).
• Dollar-weighted return equals the internal rate of return (IRR). If the exam names one, substitute the other.
• The Global Investment Performance Standards (GIPS) require time-weighted return, not dollar-weighted.
• Annualized return uses geometric (compound) averaging, not arithmetic; arithmetic overstates true compound growth.
• Sharpe ratio uses standard deviation (total risk); Treynor ratio uses beta (systematic risk).
• Positive alpha means the manager beat what the Capital Asset Pricing Model (CAPM) predicted, not just that the portfolio rose.
• A benchmark must match the portfolio's style, market capitalization, and geography; comparing a small-cap fund to the Standard and Poor's 500 (S&P 500) is the classic mismatch.

The Formulas (Reproduce Verbatim)

Current yield, bonds:

Current yield, stocks:

• Total return / holding period return (HPR): (Ending Value - Beginning Value + Income) / Beginning Value
• Expected return: Sum of (Probability x Return) for each scenario
• Sharpe ratio: (Portfolio Return - Risk-Free Rate) / Standard Deviation of Portfolio
• Treynor ratio: (Portfolio Return - 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 - Inflation Rate
• Real return, precise: (1 + Nominal) / (1 + Inflation) - 1
• Tax-equivalent yield: Municipal Bond Yield / (1 - Tax Rate)

Worked Examples to Recognize

• Premium bond: $1,000 face, 6% coupon, priced at $1,100. Current yield = $60 / $1,100 = 5.45% (below the coupon).
• Discount bond: $1,000 face, 6% coupon, priced at $900. Current yield = $60 / $900 = 6.67% (above the coupon).
• 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%.

Current Yield: Price, Coupon, and Yield to Maturity (YTM)

• Discount bond ordering: coupon rate < current yield < YTM.
• Premium bond ordering (reversed): coupon rate > current yield > YTM.

Return Measures: Which One and When

Relevant Benchmarks

• Match style (value vs. growth), cap size, geography, and asset class to the portfolio.
• Multi-asset portfolios use a custom blended benchmark (e.g., 60% S&P 500 + 40% Bloomberg Aggregate).

Top Gotchas

• 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 mandates time-weighted return; picking dollar-weighted for manager evaluation is the trap.
• The S&P 500 is large-cap U.S. only; it is the wrong yardstick for small-cap, international, or bond portfolios.
• MSCI EAFE excludes the U.S. and Canada; Russell 2000 (small-cap) is easily confused with the Russell 3000 (whole U.S. market).
• Municipal bond interest is tax-free federally (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, required by GIPS); when it asks about the investor's own experience use dollar-weighted return, which is the internal rate of return. Judge risk with Sharpe (total risk, standard deviation) for someone's whole portfolio and Treynor (systematic risk, beta) for one of many, and read positive alpha as beating the CAPM prediction rather than merely rising. Convert across time with geometric averaging, strip inflation with the real-return formula, and gross up a muni with the tax-equivalent yield. Finally, always benchmark against a matching style, cap size, and geography, because a small-cap fund measured against the S&P 500 tells you nothing honest.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Portfolio Performance Measures unit for the complete lesson.