The formula to calculate the Sharpe Ratio (SR) is:
\[ SR = \frac{IR - RFR}{SD} \]
Where:
The Sharpe Ratio is a widely used financial metric that helps investors evaluate the risk-adjusted return of an investment or portfolio. It measures how well an investment has performed relative to the level of risk taken.
The ratio is calculated by taking the excess return of the investment over the risk-free rate and dividing it by the standard deviation of the investment’s returns. The return on a government bond or a similar low-risk investment typically represents the risk-free rate.
What is the risk-free rate in the context of the Sharpe Ratio?
The risk-free rate refers to the return of an investment with zero risk, such as the return on a government bond. In the Sharpe Ratio calculation, it represents the baseline return against which the performance of the investment is compared.
