Sharpe Ratio

The Sharpe ratio measures the excess return per unit of standard deviation in an investment asset or a trading strategy. Higher the Sharpe ratio, the more return the investor is getting per unit of risk. The lower the Sharpe ratio the more the risk an investor is taking to earn additional returns.

Calculation of sharpe ratio is given by the following equation:

Sharpe ratio = (Rp - Rf) / σ

Where,

Rp= Mean portfolio return

Rf= Risk-Free rate

σ= portfolio’s standard deviation

For example, Suppose you expect that your portfolio has an annualized return of 12%. If risk-free rate is 7% and your portfolio carries a 8% standard deviation.The Sharpe ratio for your portfolio would be calculated as:

                                Sharpe Ratio = (12% - 7%)/ 8% = 0.625