Chartered Market Technician (CMT) Practice Exam

The Treynor ratio differs from the Sharpe ratio primarily in its approach to measuring risk, specifically by using CAPM beta in the denominator. This means that the Treynor ratio evaluates returns relative to systematic risk, which is the risk inherent to the entire market and cannot be diversified away.

By utilizing beta, the Treynor ratio focuses on the risk associated with the investment relative to the market's overall movements. This allows investors to assess how well a portfolio has performed in relation to the risks tied to the market, rather than the total risk of the portfolio itself.

In contrast, the Sharpe ratio measures risk using the standard deviation of the portfolio's excess return, thereby considering both systematic and unsystematic risk. As a result, the Treynor ratio is more suitable for portfolios that are already diversified, whereas the Sharpe ratio is more comprehensive in its risk assessment for less diversified portfolios.

Overall, the use of CAPM beta in the Treynor ratio underscores its focus on systematic risk, making it a valuable tool for investors looking to evaluate performance relative to market risk.