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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Portfolio Performance Measurement and Evaluation

Mr. Nair, a client, asks his adviser to compare two equity funds with different levels of total risk, where each fund is his only investment. Which measure is most appropriate for ranking them?

The Sharpe ratio is most suitable because the funds are the client's only holdings, so total risk counts. It divides excess return over the risk-free rate by standard deviation. Treynor and Jensen measures use only systematic risk (beta), which fits diversified portions of a larger portfolio.

  1. ATreynor ratio, because it uses beta
  2. BSharpe ratio, because it uses total risk (standard deviation)Correct
  3. CJensen's alpha, because it ignores the risk-free rate
  4. DSimple absolute return, because risk is not relevant

Explanation

When a fund represents the client's entire investment, total risk matters, so the Sharpe ratio, which divides excess return by standard deviation, is appropriate. Treynor and Jensen measures capture only systematic risk and suit well-diversified portfolios that are part of a larger holding. Jensen's alpha does use the risk-free rate, and absolute return ignores risk.

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