UNIT - 8

Portfolio Evaluation
1. The return and risk information for 2 mutual funds (portfolio) and a stock market index is given
below;

Mutual Fund/Portfolio Return (%) Standard Deviation Beta

(%)
X 12 18 0.70
Y 19 25 1.30
Market Index 15 20 1.00
The risk free rate of return is 7%. Evaluate the performance of two mutual funds and the market
index under;
a. Sharpe ratio
b. Treynor ratio

Solution: Evaluating Portfolio and market index performance under;

a. Sharpe Ratio = (Rp – Rf)/ σP

i. Mutual fund – X
SRX = (Rx – Rf)/σX
= (12 – 7)/18
SRX= 0.28

II. Mutual Fund – Y

SRY = (Ry – Rf)/σy

= (19 – 7)/25
SRX= 0.48

ii. Market index

SRM = (Rm – Rf)/σm
= (15 – 7)/20
SRX= 0.4

b. Treynor Ratio = TR = (Rp – Rf)/βp

i. Mutual fund – X
TRX = (Rx – Rf)/ βX
= (12 – 7)/0.70
SRX= 7.14

II. Mutual Fund – Y

 TRY = (Ry – Rf)/ βy

= (19 – 7)/1.30
SRX= 9.23

ii. Market index

TRM = (Rm – Rf)/ βm
= (15 – 7)/1.00
SRX= 8.00

Mutual Fund/Market index Sharpe Ratio Treynor Ratio

X 0.28 7.14
Y 0.48 9.23
Market Index 0.4 8.00

Interpretation: Based on the above calculations, it is observed that Mutual Fund – Y is having
greater values of both sharpe ratio and Treynor ration hence, it is evidenced that Mutual fund –
Y is performing better compared to mutual fund X and the market index.

2. Given below are the historic performance information on Capital market index and a mutual
fund for 10 years.

Year Return from Beta of Mutual Return from Return on Govt.

Mutual fund fund market index security
1 13.85 1.25 -10.00 4.76
2 28.00 1.20 21.00 4.21
3 35.00 1.18 11.05 5.21
4 11.25 1.20 -7.50 6.00
5 24.00 1.22 4.00 6.50
6 6.85 1.32 14.31 4.35
7 1.20 1.27 18.95 3.85
8 21.00 1.25 14.50 6.15
9 10.18 1.10 9.25 7.50
10 17.65 0.95 20.00 6.00
Calculate the following risk adjusted return for both market index and the mutual fund using;
a. Return to variability ratio
b. Return to volatility ratio

Solution:

Year Return from X2 Return from Y2 Beta of Return on Govt.

market index Mutual fund Mutual security
(X) (Y) fund
1 -10.00 100 13.85 191.82 1.25 4.76
2 21.00 441 28.00 784 1.20 4.21
3 11.05 122.10 35.00 1225 1.18 5.21
4 -7.50 56.25 11.25 126.56 1.20 6.00
5 4.00 16 24.00 576 1.22 6.50
6 14.31 204.78 6.85 46.92 1.32 4.35
7 18.95 359.10 1.20 1.44 1.27 3.85
8 14.50 210.25 21.00 441 1.25 6.15
9 9.25 85.56 10.18 103.63 1.10 7.50
10 20.00 400 17.65 311.52 0.95 6.00
N=10 Sum of X = Sum of X2 = Sum of Y = Sum of Y2 = Sum of Sum of Return on
95.56 1995.04 168.98 3807.89 Beta = Govt. Sec = 54.53
11.94

SR = Rp – Rf/σp

TR = Rp – Rf/βp

Rm = 95.56/10 = 9.56

Rp = 168.98/10 = 16.9

Rf = 54.53/10 = 5.45

βM = 1.00

βp = 11.94/10 = 1.19

σp , σm = ??

σm = Square root of N Sum of X2 – (sum of x)2/N2

= Square root of 10*1995.04 – (95.56)2 / (10)2

= Square root of 19950.4 – 9131.71/100

= Square root of 10818.69/100

= Square root of 108.19

σm = 10.40

σp = Square root of N Sum of Y2 – (sum of Y)2/N2

= Square root of 10*3807.89 – (168.98)2 / (10)2

= Square root of 38078.9 – 28554.98/100

= Square root of 9524.66/100

= Square root of 95.25

σP = 9.76

A. Return to variability ratio:

i. Market index
SRm = Rm – Rf/ σm
= 9.56 – 5.45/10.40
= 0.40
ii. Mutual Fund
SRp = Rp – Rf/ σp
= 16.9 – 5.45/9.76
= 1.17
B. Return to Volatility Ratio
i. Market index
TRm = Rm – Rf/ βM
= 9.56 – 5.45/1.00
= 4.11
ii. Mutual Fund
TRp = Rp – Rf/ βP
= 16.9 – 5.45/1.19
= 9.62

Mutual Fund/Market Index SR TR

Mutual Fund 1.17 9.62
Market Index 0.40 4.11

Interpretation: Based on the above calculations, it is observed that Mutual Fund is having
greater values of both sharpe ratio and Treynor ration compared to market index. Hence,
Mutual fund is performing netter than market index.

3. Following are the information available to you;

Particulars Portfolios
A B C D
Beta 1.10 0.80 1.8 1.4
Return in % 14.5 11.25 19.75 18.5
Standard 20.0 17.5 26.3 24.5
 Deviation %
Risk free rate of return is 6%. Market expected return is 12%. Calculate;
a. Sharpe Ratio
b. Treynor Ratio
c. Jensen Ratio

Solution:

a. Sharpe Ratio;
i. For Portfolio A
SRA = Rp – Rf/ σp
= (14.5 – 6)/20
SRA = 0.425
ii. For Portfolio B
SRB = Rp – Rf/ σp
= (11.25 – 6)/17.5
SRB = 0.30
iii. For Portfolio C
SRC = Rp – Rf/ σp
= (19.75 – 6)/26.3
SRC = 0.523
iv. For Portfolio D
SRD = Rp – Rf/ σp
= (18.5 – 6)/24.5
SRD = 0.510

b. Treynor Ratio
i. For Portfolio A
TRA = Rp – Rf/ βP
= (14.5 – 6)/1.10
TRA = 7.73
ii. For Portfolio B
TRB = Rp – Rf/ βP
= (11.25 – 6)/0.80
TRB = 6.56
iii. For Portfolio C
TRC = Rp – Rf/ βP
= (19.75 – 6)/1.8
TRC = 7.64
iv. For Portfolio D
TRD = Rp – Rf/ βP
= (18.5 – 6)/1.4
 TRD = 8.93

C. Jensen Ratio (Jensen Measure/ Differential Return)

Alpha P = Rp – Ex(Rp)

Ex(Rp) = Rf + βP (Rm – Rf)

i. For Portfolio A
Ex(Rp) = Rf + βP (Rm – Rf)
= 6 + 1.10(12-6)
= 6 + 6.6
= 12.6

Alpha P = Rp – Ex(Rp)

= 14.5 – 12.6

= 1.9

ii. For Portfolio B

Ex(Rp) = Rf + βP (Rm – Rf)
= 6 + 0.8(12-6)
= 6 + 4.8
= 10.8

Alpha P = Rp – Ex(Rp)

= 11.25 – 10.8

= 0.45

iii. For Portfolio C

Ex(Rp) = Rf + βP (Rm – Rf)
= 6 + 1.8(12-6)
= 6 + 10.8
= 16.8

Alpha P = Rp – Ex(Rp)

= 19.75 – 16.8

= 2.95

iv. For Portfolio D

Ex(Rp) = Rf + βP (Rm – Rf)
= 6 + 1.4(12-6)
 = 6 + 8.4
= 14.4

Alpha P = Rp – Ex(Rp)

= 18.5 – 14.4

= 4.1

Portfolio SR TR JR
A 0.425 7.73 1.9
B 0.3 6.65 0.45
C 0.523 7.64 2.95
D 0.510 8.93 4.1
Interpretation: Based on the above calculations, it is observed that under sharpe ratio portfolio C is
performing better with greater value of 0.523. Under Treynor ratio portfolio D is performing better with
greater value of 8.93. Similarly under Jensen ration portfolios A, C, and D are generating superior returns
compared to portfolio B which is giving a neutral return.