Final answer:
The Treynor ratio is the performance measure that computes the risk premium per unit of systematic risk and uses the systematic risk of the portfolio as its risk parameter. It is a valuable tool for comparing investments with similar expected returns but differing levels of systematic risk.
Step-by-step explanation:
The performance measure that computes the risk premium per unit of systematic risk is known as the Treynor ratio. The Treynor ratio uses beta, which is a measure of an investment's systematic risk relative to the overall market, as its risk parameter. Systematic risk is the part of an investment's risk that cannot be diversified away, meaning it is inherent to the entire market or market segment.
The expected rate of return is a key concept related to the Treynor ratio as it indicates what an investor can anticipate earning from an investment, taking into consideration factors such as interest payments, capital gains, and profitability over time. On the other hand, the actual rate of return is what the investor really earns at the end of an investment period, including capital gains and interest. Both of these are considered with respect to the systematic risk to derive the Treynor ratio.
When comparing two investment options with a similar expected return, a rational investor would choose the one with the lower systematic risk, as indicated by a higher Treynor ratio. This decision process underlines the tradeoff between risk and return in financial decision-making.