Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

What is defined as an ex post excess return?

1. Future return minus projected return

2. A return expressing gains above risk-free return

3. Total return minus risk-adjusted return

4. Realized return above the investment cost

The correct answer is: A return expressing gains above risk-free return

An ex post excess return specifically measures the return that an investment generates above the risk-free rate, taking into account the returns that have already been realized. This concept is crucial in performance evaluation as it helps investors understand how much additional return they have received compared to what they could have earned from investing in a risk-free asset, such as government treasury bills. This definition highlights the risk premium that investors earn for taking on additional risk by investing in riskier assets. By focusing on the difference between the realized returns and the risk-free rate, it provides a clear assessment of the investment's performance after the fact, giving a tangible metric for comparison against low-risk alternatives. The other definitions do not accurately capture the essence of ex post excess return. For instance, future returns do not account for actual performance and the projected return does not provide a reliable benchmark following the fact. Similarly, total return minus risk-adjusted return mixes different performance evaluation concepts and does not specifically address excess returns in relation to the risk-free rate. Lastly, realized return above investment cost refers to profit in relation to expenditure rather than a benchmark comparison, which does not align with the established definition of ex post excess return.