Financial Risk Manager Part 1

Explanation

The correct answer is A.

Key Differences Between Treynor and Sharpe Measures:

Treynor Measure:

• Uses beta as the risk measure
• Beta measures the volatility of a portfolio relative to the market
• Only considers systematic risk (market risk that affects all securities)
• Systematic risk cannot be eliminated through diversification

Sharpe Measure:

• Uses standard deviation as the risk measure
• Standard deviation measures the total risk of the portfolio
• Includes both systematic and unsystematic risk
• Unsystematic risk is unique to individual securities and can be eliminated through diversification

Why Other Options Are Incorrect:

Option B: Incorrect - The Sharpe measure does NOT use beta; it uses standard deviation. The Treynor measure uses beta, not standard deviation.

Option C: Incorrect - The complexity of calculation is not a primary distinction between the two measures. Both are relatively straightforward to calculate when the required data (returns, beta, or standard deviation) are available.

Option D: Incorrect - Both measures can be used for any type of portfolio, regardless of diversification level. The Sharpe measure is particularly useful for evaluating portfolios that are not well-diversified since it considers total risk.

Practical Implications:

• Treynor Ratio is better for well-diversified portfolios where unsystematic risk has been minimized
• Sharpe Ratio is more appropriate for portfolios that may not be fully diversified, as it accounts for both systematic and unsystematic risk
• Both ratios help investors compare risk-adjusted returns across different portfolios or investment strategies