Risk, Return and Performance of Funds for NISM certification
To explain a fund honestly, a distributor must know where its returns come from, what can go wrong, and how to measure both. This chapter covers the drivers of equity, debt and gold returns, the formulas for measuring returns, and risk and risk-adjusted measures.
Mutual FundsSeries V-A62 MCQs5 lessons28 flashcards5 memory tricks
Practise Risk, Return and Performance of Funds free
What you'll learn
- What drives equity returns
Explain how earnings and valuations drive share prices, and name common investing styles. - What drives debt returns
Link interest rates, credit quality and duration to a debt fund's returns. - Measuring returns
Compute absolute, annualised and compound annual returns, and know when to use each. - Measuring risk
Read standard deviation, beta and drawdown from a factsheet. - Risk-adjusted returns
Compute Sharpe, Treynor and alpha and decide which fund did better for the risk taken.
Key formulas
| P/E ratio | Share price ÷ earnings per share (EPS) |
|---|---|
| P/B ratio | Share price ÷ book value per share |
| Dividend yield | Dividend per share ÷ share price |
| Equity return (roughly) | Earnings growth + change in valuation (P/E) + dividend yield |
| Current yield | Annual coupon ÷ market price |
| Modified duration | Macaulay duration ÷ (1 + yield) |
| Price change (approx.) | − Modified duration × change in yield |
| Credit spread | Corporate bond yield − government bond yield of similar maturity |
Concepts explained
CAGR and annualised returns
CAGR is the steady yearly rate that turns the start value into the end value: (end ÷ start)^(1/years) − 1. For periods under a year, use simple annualised return.
What it means
- Absolute return ignores time.
- Simple annualised = absolute × 365 ÷ days.
- CAGR includes compounding.
- ₹40,000 → ₹48,400 in 2 years
- 48,400 ÷ 40,000 = 1.21
- √1.21 = 1.10
Answer: CAGR = 10%
- ₹1,00,000 → ₹1,03,000 in 3 months
- Absolute 3%
- 3% × 12 ÷ 3
Answer: 12% a year
Duration
Duration measures a bond's sensitivity to interest rates: modified duration ≈ % price change for a 1% change in yield.
What it means
- Macaulay duration is the weighted average time to receive cash flows.
- Modified duration = Macaulay ÷ (1 + yield).
- Longer duration → bigger price change when rates move.
- Modified duration 6
- Yields fall 0.25%
- 6 × 0.25% = 1.5%
Answer: Price rises about 1.5%
Related terms
- YTM: return if held to maturity with all payments made
Sharpe and Treynor ratios
Sharpe divides excess return by standard deviation (total risk); Treynor divides it by beta (market risk). Higher is better.
What it means
- Excess return = fund return − risk-free rate.
- Use Sharpe for a fund that is most of the portfolio; Treynor for a diversified fund within a portfolio.
- Return 13%, Rf 6%, SD 14%
- (13 − 6) ÷ 14
Answer: 0.5
- Return 13%, Rf 6%, beta 0.7
- 7 ÷ 0.7
Answer: 10
Alpha
Alpha is the return a fund earned above what its beta predicted: Rp − [Rf + β(Rm − Rf)].
What it means
- Positive alpha suggests manager skill (or luck).
- Depends on the benchmark chosen.
- Rp 11%, Rf 6%, β 0.9, Rm 10%
- Expected = 6 + 0.9 × 4 = 9.6%
Answer: Alpha = 1.4%
Standard deviation and beta
Standard deviation measures total volatility; beta measures movement relative to the market.
What it means
- SD in % units; higher = more volatile.
- Beta 1 = moves with market; above 1 = more; below 1 = less.
- About 68% of returns lie within ±1 SD of the average (normal distribution).
Memory tricks
Bond prices fall when yields rise and rise when yields fall.
Sharpe uses standard deviation (σ); Treynor uses beta.
BBB is the lowest investment grade; BB and below are speculative; D is default.
CAGR = the constant annual rate giving the same end value.
About two-thirds of returns lie within one standard deviation of the mean.
Try 3 NISM-style questions
Q1. Absolute return is most appropriate for
- Comparing a 3-year return with a 5-year return
- Measuring the return on a SIP with many instalments
- Debt fund duration
- Periods of less than a year, without annualising for comparison
Show answer
Answer: (4) Periods of less than a year, without annualising for comparison
Absolute returns aren't comparable across periods.
Q2. The Treynor ratio uses which measure of risk?
- Standard deviation
- Beta
- Duration
- Expense ratio
Show answer
Answer: (2) Beta
Treynor divides excess return by beta.
Q3. A bond with a coupon of 8% on face value ₹100 trades at ₹95. Its current yield is about
- 8.00%
- 7.60%
- 8.42%
- 5.00%
Show answer
Answer: (3) 8.42%
8 ÷ 95 = 8.42%.
Practise all 62 questions Free · explanations for every option · see where you go wrong