2013 CFA morning exam

[derswap07]

Q 11 Part B: Answer:
i. Rigel is most appropriate for Client 1 on a risk-adjusted basis.
Total risk is most relevant for a portfolio which is not fully diversified. With all his assets invested in a stand-alone energy sector fund, Client 1 does not hold a fully diversified portfolio. Therefore, the Sharpe ratio is the most appropriate risk-adjusted performance measure for
Client 1 because it compares a portfolio’s excess return to its total risk. Rigel has the highest Sharpe ratio of the three funds.
ii. Procyon is most appropriate for Client 2 on a risk-adjusted basis.
Beta risk is most relevant for a portfolio in which nonsystematic risk has been diversified away. Since Client 2 holds a well-diversified portfolio, the Treynor measure is the most appropriate risk-adjusted performance measure because it compares a portfolio’s excess return relative to its systematic risk, represented by beta. Procyon has the highest Treynor measure of the three funds.
Can anyone better explain the reasoning ? I picked exactly the opposite.

 

[Rogue Trader]

Since Client 1 want to invest all of his asset in an energy sector fund (has a positive view) and hence portfolio is not diversified so total risk is most appropriate and Sharpe ratio captures this risk, so choosing highest sharp ratio will earn postive excess return which is Rigel
Client 2, since its diversifiable risk, non-systematic risk doesnt exist (only systematic risk) and hence, Beta is a measure of systematic risk, and Trynor ratio captures this risk. Take the highest Treynor measure ratio which is Procyon.

 

[Audacious]

Technically Sharpe ratio should work for both . SD = systematic + nonsystematic risk. For fully diversified portfolio , nonsystematic risk equals zero.
Now for CFA, forget what I’ve just said. Use Trynor for fully diversified portfolios.

 

[derswap07]

THanks for your explanation Rogue trader