Financial Risk Manager Part 1
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Which of the following portfolio performance evaluation measures is (are) only based on systematic risk?
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TTanishq
A
Sharpe ratio
B
Treynor ratio
C
All of the above
D
None of the above
Explanation:
Explanation
The Treynor ratio is the only portfolio performance evaluation measure among the options that is based solely on systematic risk.
Key Differences:
Treynor Ratio:
- Uses systematic risk (beta) as the denominator
- Formula: (Portfolio Return - Risk-Free Rate) / Beta
- Only considers market risk that cannot be diversified away
Sharpe Ratio:
- Uses total risk (standard deviation) as the denominator
- Formula: (Portfolio Return - Risk-Free Rate) / Standard Deviation
- Considers both systematic and unsystematic risk
Why B is Correct:
- Systematic risk (beta) measures a portfolio's sensitivity to market movements
- Treynor ratio specifically focuses on this market-related risk
- It assumes investors hold well-diversified portfolios where unsystematic risk is eliminated
Why A is Incorrect:
- Sharpe ratio uses total risk, which includes both systematic and unsystematic components
- It doesn't distinguish between diversifiable and non-diversifiable risk
Therefore, only the Treynor ratio is exclusively based on systematic risk.
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