Definition of Treynor Ratio
Jack Treynor found the formula for the Treynor Ratio. It is the ratio that measures returns earned in surplus of which could have been earned on a risk free speculation per each unit of market risk. The excess return is the difference between a group’s return and the risk-free rate of return of the same period of time.
This means that it is the ratio that helps us ascertain the risk-adjusted measure based on methodical risk. Treynor Ratio is similar to Sharpe Ratio, the only difference being that Treynor Ratio uses “beta” to measure unpredictability.
Formula for calculating Treynor Ratio
The Treynor Ratio can be calculated with the help of the following formulas:
= (Average Return of the Portfolio - Average Return of the Risk-Free Rate) / Beta of the Portfolio
rp = returns of the portfolio
rf = return of risk free instrument
And Bp = beta of the portfolio
Treynor Ratio helps in ascertaining the group’s returns which are earned in excess, and what of it could be earned by a risk-free investment. It is said that it is better if the Treynor ratio is high as it means that the group’s performance is good and the stock has been well evaluated.
Whenever you notice that the Treynor Ratio is high it means that the investor has received high returns on each market risk he has taken. Treynor’s Ratio is important to a portfolio as it helps in understanding how the funds of the business will perform not only on its own instability but also how it can bring about unpredictability to the overall business.
Beta is an extensively used measure of market-related risks of stock and is known as the measurement of market-related risk. The Treynor’s Ratio divides the excess return of a group by its beta. It can help an investor in ascertaining the returns that can be generated by funds over short term investments.
Like the Sharpe Ratio, the Treynor Ratio does not calculate the actual value but is a simple grading method. While Sharpe Ratio uses the standard deviation of a portfolio, Treynor Ratio makes use of the systematic risk or the beta of the portfolio. Treynor Ratio might have its own flaws, but is still one of the most preferred formulas like the Sharpe Ratio as it is easy to ascertain the risks and values of investments of a portfolio.