Sharpe Ratio

The Sharpe ratio is a financial metric used to assess the risk-adjusted return of an investment. It is calculated by dividing the excess return of the investment (over the risk-free rate) by its standard deviation, which represents the investment’s risk. A higher Sharpe ratio indicates that an investment provides better returns relative to its risk, while a lower ratio suggests less favorable risk-adjusted returns.

Example

An investor compares two mutual funds: Fund A has a Sharpe ratio of 1.5, and Fund B has a Sharpe ratio of 0.8. Fund A is deemed a better risk-adjusted investment.