CA Final · Advanced Financial Management · Mutual Funds
Two schemes are compared over the same period with a risk-free rate of 5%. Scheme P: return 17%, standard deviation 15%, beta 0.9. Scheme Q: return 19%, standard deviation 24%, beta 1.4. Market return is 13%. Which conclusion is correct?
Scheme P ranks higher on both measures. Its Sharpe ratio is 0.80 against 0.58 for Q, and its Treynor ratio is 13.33 against 10.0 for Q. Q's higher raw return does not compensate for its much greater total and systematic risk.
- AP ranks higher on Sharpe but Q ranks higher on Treynor
- BQ ranks higher on both Sharpe and Treynor
- CP ranks higher on Sharpe and on TreynorCorrect
- DQ ranks higher on Sharpe but P ranks higher on Treynor
Explanation
Sharpe P = 12/15 = 0.80; Q = 14/24 = 0.583. Treynor P = 12/0.9 = 13.33; Q = 14/1.4 = 10.0. P is higher on both. Looking only at the higher raw return of Q is the trap.
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