CAIA Chapter 5: Correlation, Alternative Returns and Performance Measurement

when incentive fees are awarded separately based on the performance of each individual investment

limits incentive fees to profits in excess of the hurdle rate

allows fund managers to earn an incentive fee on all profits, given that the hurdle rate has been achieved

refers to the degree to which an option is in-the-money, near-the-money, or out-of-the-money

1.For a call option, when the option's strike price is below the market price of the underlying asset. 2 For a put option, when the strike price is above market price of underlying asset. Being in the money does not mean you will profit, but worth exercis

A call option with a strike price that is higher than market price of the underlying asset, or a put option with a strike price that is lower than the market price of underlying asset. If it still out of the money at expiry, the option will expire worthle

the most popular measure of risk-adjusted performance for traditional investments and traditional invetment strategies . May be interpreted as the annual risk premium that the investment earned per percentage point in annual standard deviation

is traditionally interpreted as containing only trivial amounts of diversifiable risk

uses beta as the measure of risk in the denominator rather than standard deviation. may be interpreted as the risk premium that the investment earns per unit of beta. Excess return earned by bearing systemic risk

used more in alternative investments. The emphasis of the Sortino ratio is the use of downside reisk rather than the use of a target rate of return

divides active returns by tracking error. The typical amount by which a portfolio's return deviates from its benchmark.It is the amount of added return if positive, that portfolio generated relative to benchmark for each % by which the pf's return deviate

is a direct measure of the absoute amount by which an asset is estimated to outperform, if positive, the return on efficiently priced assets of equal systematic reisk in a single-factor market model

expresses the excess return of an investment after its risk has been normalized to equal the risk of the market portfolio.

involves the differences between the returns of a particular strategy and its benchmark (standard deviation)

simply refers to the excess of an investment's return relative to its benchmark. In other words, the nummerator of the information ratio.

Like covariance it measures the degree of association between two variables

-1. two assets move in the exact opposite direction

+1. two assets move in the exact same direction and in the same proportion

based on the ranked size of the variables rather than the absolute size. Rank correlations are sometimes preferred because of the way rank correlation handles the effects of outliers

measures added systematic risk as a proportion of the risk of the index. The beta of an asset may be viewed as the percentage return response that an asset will have an average to a 1 %age point movement in the related risk factor, such as overall market

can be used as a general term to describe possible relationships between the returns of an asset from different time periods.

refers to the correlation between return in time period t and the return in the immediately previous time period t-1

can be defined as the discount rate that equates the present value of the costs (cash outflows) of an investment with the present value of the benefits (cash inflows) from the investment. The IRR is the discount rate that makes the NPV of investment = 0

containing all the cash flows, realized or anticipated, occurring over the investment's entire life (no appraisal or terminal value)

the key to an interim IRR is that CFt is a residual valuation based on professional judgment rather than an actual liquidation cash flow

If CF0 and the CFt are both appraised values or other values during the lifetime of the investment (i.e. after inception and before termination) than the IRR tends to be known as a point-to-point IRR

is an investment involving borrowing or multiple sign changes

IRR must be interpreted differently. Here high IRR is undesirable because the IRR is revealing the cost of borrowing

whenever there is more than one sign change in the cash flow stream, more than one IRR may exist