Sharpe Ratio Calculator

The Sharpe Ratio is a measure used to evaluate the performance of an investment compared to its risk. Developed by Nobel laureate William F. Sharpe, it is a critical tool in the arsenal of investors, allowing them to understand the return of an investment compared to its risk.

Historical Background

The Sharpe Ratio, introduced in 1966 by William F. Sharpe, aims to measure the performance of an investment by adjusting for its risk. The higher the Sharpe Ratio, the better the investment's risk-adjusted return.

Calculation Formula

The formula for the Sharpe Ratio is:

\[ \text{Sharpe Ratio} = \frac{R_p - R_f}{\sigma_p} \]

where:

• \(R_p\) is the return of the portfolio,
• \(R_f\) is the risk-free rate,
• \(\sigma_p\) is the standard deviation of the portfolio's excess return.

Example Calculation

If a portfolio returns 12%, the risk-free rate is 5%, and the standard deviation of the portfolio's excess return is 10%, the Sharpe Ratio is calculated as:

\[ \text{Sharpe Ratio} = \frac{12\% - 5\%}{10\%} = 0.7 \]

Importance and Usage Scenarios

The Sharpe Ratio is widely used by investors to analyze the risk-adjusted return of an investment. It is particularly useful for comparing the performance of different investments or portfolios.

Common FAQs

1. What does a higher Sharpe Ratio indicate?

   • A higher Sharpe Ratio indicates a better risk-adjusted return on an investment.

2. Can the Sharpe Ratio be negative?

   • Yes, a negative Sharpe Ratio indicates that the risk-free rate exceeds the return of the portfolio.

3. Is a higher or lower standard deviation better when calculating the Sharpe Ratio?

   • A lower standard deviation is better because it indicates lower volatility and, therefore, lower risk for the investment's return.

This calculator facilitates the calculation of the Sharpe Ratio, making it accessible for investors to assess the risk-adjusted performance of their investments efficiently.