**Sharpe Ratio**- It uses standard deviation, not beta, as a measure of volatility.
- The ratio itself is not very informative.

**Treynor Ratio****M-Squared (M**^{2})**Jensen's Alpha**_{p}= R_{p}- [R_{f}+ β(R_{m}- R_{f})]. Since the CAPM return is supposed to be risk-adjusted, Jensen's α is also risk-adjusted. Investors are constantly seeking investments that have positive α or "abnormal returns."

If an investor holds a portfolio that is not fully diversified, total risk matters. Sharpe ratio and M-squared are appropriate performance measures in such cases. On the other hand, if the portfolio is well-diversified, Treynor ratio and Jensen's alpha are relevant, as only the systematic risk of the portfolio matters.

While there is only one SML, there are many different SCLs for securities with different betas.

All assets and all portfolios should plot on the SML.

- Stock C has an estimated rate of return equal to its systematic risk or required rate of return.
- Stock B is expected to provide a rate of return above the required rate of return.
- Stock A is expected to provide a rate of return below the required rate of return.
- Investors should buy B (undervalued).
- Investors should sell A (overvalued).

As the number of securities increases, the portfolio manager can eliminate unsystematic risk (or

To construct a market portfolio you can start with a portfolio of securities like the S&P 500. You can then evaluate the α of any security, using the CAPM and the S&P 500 as the market portfolio. If the α is positive, add the security to the portfolio. If a security's α is negative and it is already included in the portfolio, remove it. You can also use the information ratio of each individual security to determine the relative weight of the security in the portfolio.

papajeff: It would be easier to be interested in this if any of it actually worked. |

johntan1979: It IS easy to be interested in this if $1,000 bucks means a lot to you and one question from this topic is all that matters between passing and failing. |

robertucla: yes, kind of sucks we still have to learn this even though most of this proven wrong |

jonan203: right or wrong, there are two sides to every trade and knowing how your enemy thinks will give you an edge over any trades they make.know thine enemy = victory |

RamaG: @jonathan: as important 1k might be, having to re-appear in 6 mos / 1 yr and re- read L1 LOS and missing the boat on L2 by 6 mos - 1 yr is a motivation enought to go thought every line comprehensively :)) |

Allen88: ut doesn't a positive alpha comes from most recent returns and thus we still have uncertainty about its future returns??? |