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CA Final · Advanced Financial Management · Mutual Funds

Which statement about the Sharpe and Treynor measures for evaluating mutual fund schemes is correct?

Treynor's measure divides excess return by beta, so it considers only systematic risk and fits a fund held within a well-diversified portfolio. Sharpe's measure divides by standard deviation, capturing total risk, and suits evaluating a fund as the investor's entire portfolio.

  1. ASharpe uses standard deviation, so it suits a fund that is only one part of a well-diversified portfolio
  2. BTreynor uses beta, so it is appropriate when the fund is part of a well-diversified portfolio where unsystematic risk is diversified awayCorrect
  3. CBoth measures use beta in the denominator
  4. DTreynor uses total risk and Sharpe uses systematic risk

Explanation

Treynor divides excess return by beta, capturing only systematic risk, which is relevant when unsystematic risk has been diversified away. Sharpe divides by standard deviation (total risk), suiting evaluation of a whole portfolio. The option reversing these roles is wrong.

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