Question

Bill Smith is evaluating the performance of four large-cap equity portfolios: Funds A, B, C, and D. As part of his analysis, Smith computed the Sharpe ratio and the Treynor's measure for all four funds. Based on his finding, the ranks assigned to the four funds are as follows: Fund Treynor Measure Rank Sharpe Ratio Rank A 1 4 B 2 3 C 3 2 D 4 1 The difference in rankings for Funds A and D is most likely due to:

Answer 1

Question Completion with Options:

a. A lack of diversification in fund A as compared to fund D.

b. Different benchmarks used to evaluate each fund’s performance.

c. A difference in risk premiums.

Answer:

The difference in rankings for Funds A and D is most likely due to:

a. A lack of diversification in fund A as compared to fund D.

Explanation:

a) Data and Calculations:

Fund   Treynor Measure Rank   Sharpe Ratio Rank

A                           1                                 4

B                           2                                3

C                          3                                 2

D                          4                                 1

b) The Sharpe ratio and the Treynor measure are two financial performance ratios that measure the risk-adjusted rate of return of an investment. Specifically, the Sharpe ratio helps investors to understand an investment's return profile when compared to its risk profile.  On the other hand, the Treynor ratio measures the excess return generated for portfolio risk per unit.  

In conclusion, the Sharpe ratio appears to be a better measure with  a portfolio that is not properly diversified, while the Treynor ratio works better with a well-diversified portfolio.