Question

write a one-page paper on how you would conduct a performance evaluation about an investment into a new market.

Answer 1

There are mainly focus on two parameter for evaluation of the investment into the market (mainly stock market)

1. Treynor measurement
2. Sharpe ratio

A. Treynor measurement:- Jack Lawrence Treynor was an american economist who served as the president of Treynor Capital Management in California. According to Treynor, there are two components of risk :-

1. risk of uncertainty in stock market.
2. risk of uncertainty in individual stock.

Treynor measure formula is also known as reward to volatility ratio, the formula for the same is:-

PR= Portfolio Return

RFR=Risk free Return

= Beta coefficient is the volatility measure of a portfolio with the stock exchange. Higher the value of beta higher the stock will be volatile. If the value of beta is positive then if the stock exchange increase then the value of that portfolio will also increase similar will be the case with negative beta.

lets take an example to understand this:-

Portfolio	Average return	beta value
A	8%	0.85
B	12%	1.25
C	20%	1.85

Lets take risk free rate of return be 5%. (U.S government Treasury bond)

By putting the above values in the treynor's formula :

Portfolio	Treynor's value
A	0.035
B	0.056
C	0.085

Higher the treynor's Ratio ,better will be the portfolio.

B. Sharpe Ratio:- Sharpe ratio is very much similar to the treynor's ratio. The only change in that instead of beta value the sharpe ratio used SD i.e. standard deviation.

Formula for the Sharpe Ratio is :-

PR = Portfolio Return

RFR=Risk free return

SD= Standard deviation

By using the above similar example, we will try to find sharpe ratio:-

Portfolio	Average return	Standard Deviation
A	8%	0.11
B	12%	0.20
C	20%	0.27

By putting the above values in the Sharpe Ratio formula :

Portfolio	Sharpe Ratio
A	0.27
B	0.35
C	0.55

in case of sahrpe ratio, the highest sharpe ratio is not considered as the best ratio but the superior portfolio must have the better risk adjusted return and in this case portfolio B will be considered better than the rest one.

unlike the trenyor's ratio, Sharpe ration evaluates the portfolio of the basis of rate of return and diversification both because everything in excess harms the portfolio.