Financial modelling terms explained

# Sharpe Ratio

The Sharpe ratio is a measure of the risk-adjusted performance of an investment. It compares the returns of a security with its volatility.

## What Is Sharpe Ratio?

The Sharpe Ratio is a measure of the return earned on an investment relative to the risk taken in order to obtain that return. It is named after William F. Sharpe, who developed the ratio in 1966. The Sharpe Ratio is used to help investors compare different investments and determine which offer the best risk-adjusted returns.

The Sharpe Ratio is calculated by taking the average return earned on an investment over a given period of time, subtracting the risk-free rate of return, and dividing the result by the standard deviation of the investment's returns. The Sharpe Ratio measures how much extra return an investor gets for taking on additional risk. A higher Sharpe Ratio indicates that an investment offers a higher return for the amount of risk taken.

## How Do You Calculate Sharpe Ratio?

The Sharpe ratio is a measure of risk-adjusted performance. It is calculated by dividing the excess return of an investment portfolio over the risk-free rate of return by the standard deviation of the excess returns.

## Who Uses Sharpe Ratio?

The Sharpe ratio is most often used by investors and analysts to measure the risk-adjusted performance of an investment or investment portfolio. It is used to help determine whether an investment is worth holding in light of the risk associated with it. The Sharpe ratio can also be used to compare the risk-adjusted performance of different investments.

## What Do You Have to Watch out for When You're Using Sharpe Ratio?

The Sharpe ratio is a popular measure of risk and reward that is used by investors and financial analysts. It is calculated by dividing the excess return of a security or portfolio over the risk-free rate by the standard deviation of the excess return. While the Sharpe ratio can be a useful tool for evaluating investments, it is important to be aware of its limitations.

One potential downside of the Sharpe ratio is that it can be misleading if the risk-free rate is not accurately estimated. Additionally, the Sharpe ratio can be influenced by the time period over which it is calculated. For example, a security that has a high return over a short time period may have a high Sharpe ratio, even if it is risky. Conversely, a security that has a low return over a long time period may have a low Sharpe ratio, even if it is relatively safe.

## What's the Difference Between Sharpe Ratio and Alpha?

The Sharpe Ratio is a measure of risk-adjusted performance. It takes into account the volatility of a portfolio or fund and compares it to the returns achieved by that portfolio or fund. The Sharpe Ratio is calculated by dividing the excess return of the portfolio or fund by the standard deviation of that excess return.

Alpha is a measure of how much a portfolio manager has added or subtracted from the return of their benchmark. Alpha is calculated by subtracting the benchmark's return from the portfolio's return and then dividing that number by the standard deviation of the benchmark's return.

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