2013 Exam AM - 11B - Treynor vs Sharpe

CFA Level III
#1

Hi,

I just finished this exam and I answer this question in the other way around and I am confused now with traynor and sharpe.

Please correct me / explain if I am wrong:

Treynor is the valid measure when you have a diversified portfolio and Sharpe is the right one when you have a non diversified portfolio

In the questions that a manager is showing a above benchmark Treynor and a below benchmark Sharpe, that is because he has a DIVERSIFABLE RISK IN HIS PORTFOLIO… Is that right? or is it in the other way around?

Thanks

S

#2

Client 1: Not a diversified portfolio (has systematic and non systematic risk) - so use total risk - so select best Sharpe

Client 2: Has a diversified porfolio (only systematic risk remains) - so use beta as best measure of risk - so select best Treynor

Does this make sense?

#3

Yes, but my question is focused on the questions when a manager has a high Treynor (over benchmark) and a low Sharpe…

That is because his portfolio has a diversifiable risk? Or is in the other way around?

#4

High Treynor (above benchmark) means manager is generating better returns for each unit of systematic risk.

Same for Sharpe for total risk.

#5

in a well diversified portfolio it is assumed risk is diversified away except for systemic risk. So you are looking for the best return on systemic risk, which is what Treynor measures.

If you are not well diversified you will be concerned with total risk as that is not diversified away. Sharpe ratio measures this. I honestly kind of guessed on this question and got if right somehow but it makes sense once you read it.

#6

I got them backwards when I did this question. The above explanations make perfect sense when you think about it though.

#7

If Portfolio A outperforms Portfolio B on the Treynor measure but underperforms Portfolio B on the Sharpe measure, then Portfolio A has a lot more unsystematic (diversifiable) risk.

Treynor uses beta so it captures systematic risk only. Sharpe uses standard deviation so it captures both systematic and unsystematic risk.

Thank you for the explanations now makes sense

#8

Where can you get 2013 AM Exam? I’ve searched Google several times for it and haven’t found that one.

#9

Sharpe Denominator: Standard Dev aka total risk

Treynor Denominator: Beta aka Systematic risk

Assuming numerator is the same (and it should be) and that systematic risk is the same (and it should be), then the portfolio has more unsystematic risk. This increases the value in the denominator which would lower Sharpe.

#10

Snah

I think you got it backwards??!!!

#11

That is the anwser from one of the Kaplan teachers… i think is right and make sense!

#12

What do you think is the answer that would worth max point here? I am always struggling with the level of details that I should give, so what do you think, out of the 6 points how much would I received for the following answers:

a,

i, Client 1 should choose Rigel as it has the highest sharpe ratio.

ii, Client 2 should choose Procyon as it has the highest T measure.

b,

i, Client 1 should choose Rigel as it has the highest Sh ratio and since he plans to invest all of his assets he should be concerned with the total risk of the investment.

ii, Client 2 should choose Procyon as it has the highest T measure and since he has a well diversified portfolio, he should be concerned with the systematic risk of the investment.

c,

i, Client 1 should choose Rigel as it has the highest Sh ratio and since he plans to invest all of his assets he should be concerned by the total risk, not only with the systematic risk.

ii, Client 2 should choose Procyon as it has the highest T measure and since he has a well diversified portfolio, he should be concerned with the systematic risk of the investment, not the total risk.

So my thing is that I think only c is appropriate if I look at the answers separately. However, a and b also shows I an understanding of the topic, just with varying details. Or is it possible that c is still not enough?