The concept of the Sharpe ratio is to measure the:

The concept of the Sharpe ratio is to measure the:

A. Amount of performance attributable to a benchmark

B. Return above a risk-free rate

C. Effect the annual charge has on fund performance

D. Ability of the fund manager in different scenarios

View Answer

Answer: B

Explanation:

Sharpe Ratio Defined

The Sharpe ratio measuresrisk-adjusted return, specifically the excess return over the risk-free rate per unit of volatility.

Formula: Sharpe Ratio=Portfolio Return – Risk-Free RateStandard Deviation of Portfolio Returns ext{Sharpe Ratio} = rac{ ext{Portfolio Return – Risk-Free Rate}}{ ext{Standard Deviation of Portfolio Returns}}Sharpe Ratio=Standard Deviation of Portfolio ReturnsPortfolio Return – Risk-Free Rate? Why the Answer is B

The ratio quantifies the return generated for each unit of risk taken, relative to the risk-free rate.

Why Other Options are Incorrect

A. Benchmark performance: The Sharpe ratio does not measure performance relative to a benchmark.

C. Annual charge effect: Unrelated to fund expenses.

D. Manager ability: Focuses on risk-adjusted returns, not managerial skill.

ICWIM Study Guide, Chapter on Risk-Adjusted Metrics: Explains the Sharpe ratio.

Portfolio Management Literature: Highlights its use in assessing performance.

Reference: Thus, the correct answer isB. Return above a risk-free rate.