Description
The Sharpe Ratio is a widely used financial metric that measures the risk-adjusted return of an investment or a portfolio. It quantifies the excess return generated by an investment per unit of risk taken, typically using the standard deviation of returns as a proxy for risk. The Sharpe Ratio is calculated by subtracting the risk-free rate of return from the average return of the investment or portfolio, and then dividing the result by the standard deviation of returns. Mathematically, the formula for the Sharpe Ratio is (Rp - Rf) / σp, where Rp is the average return of the investment or portfolio, Rf is the risk-free rate of return, and σp is the standard deviation of returns. A higher Sharpe Ratio indicates a better risk-adjusted return, implying that the investment or portfolio has generated more return for each unit of risk assumed. The Sharpe Ratio helps investors and portfolio managers evaluate and compare the performance of different investment opportunities or portfolios, allowing them to make more informed decisions about risk and return trade-offs.