FREE CASH FLOW FORMULA CFA LEVEL 2 FREE

The optimal amount of active risk that maximizes the Sharpe ratio but keeps the same information ratio can be determined by: The information ratio is a key criterion on which to evaluate actively managed portfolios. This implies that the higher the information ratio, the higher the Sharpe ratio. With an actively managed portfolio and the benchmark portfolio, we can adjust active risk and return of our portfolio. With a risk-free asset and a single risky portfolio with the maximum Sharpe ratio, we can adjust absolute risk and return of our portfolio. Note the LOS requires that you 'calculate and interpret the information ratio and contrast it to the Sharpe ratio.' This section is not required. This is because both the active return and active risk increase proportionally. The information ratio will remain unchanged if all the active security weights are multiplied by a constant.

Unlike the Sharpe ratio, the information ratio is affected by the addition of cash or the use of leverage.The information ratio helps investors focus on the relative value added by active management. The Sharpe ratio compares the return of an asset against the return of Treasury bills the information ratio compares excess return to the most relevant equity (or debt) benchmark index.Higher information ratio portfolios can be used to create higher Sharpe ratio portfolios.Both ratios can be applied ex ante to expected returns or ex post to realized returns.Where active return = R P - R B = R A and active risk = STD(R A). While the Sharpe ratio measures reward per unit of risk in absolute returns, the information ratio measures reward per unit of risk in benchmark relative returns. The investor can then adjust risk and return based on his/her preference. An investor should form portfolios with two funds: one is the risk-free asset and the other is the risky portfolio with the highest Sharpe ratio. The Sharpe ratio is unaffected by the addition of cash or leverage in a portfolio. The convention is to annualize both the return and standard deviation. The mean monthly return on the S&P 500 is 1.30% with a standard deviation of 7.30%. The mean monthly return on T-bills (the risk-free rate) is 0.25%. The Sharpe ratio can be used as an ex ante measure of expected return and risk or an ex post performance of a portfolio over some time period.

FREE CASH FLOW FORMULA CFA LEVEL 2 FREE

5 Free Cash Flow to the Firm (FCFF) Free Cash Flow to the Firm or FCFF (also called Unlevered Free Cash Flow) requires a multi-step calculation and is used in Discounted Cash Flow analysis to arrive at the Enterprise Value (or total firm value.

Portfolios with large Sharpe ratios are preferred to those with smaller ratios because we assume that investors prefer returns and dislike risk. FCFE (Levered Free Cash Flow) is used in financial modeling to determine the equity value of a firm. The Sharpe ratio is also called the reward-to-variability ratio. STD(R P): the standard deviation of the portfolio returns.The Sharpe ratio measures the reward to total volatility trade-off.

Free cash flow formula cfa level 2