Sharpe Ratio Calculator

1. What is the Sharpe Ratio Calculator?

Definition: The Sharpe Ratio Calculator computes the Sharpe Ratio, a measure of risk-adjusted return that evaluates an investment's performance by comparing its excess return over a risk-free rate to its standard deviation.

Purpose: It helps investors assess the return of an investment relative to its risk, aiding in portfolio optimization and comparison of investment options.

2. How Does the Calculator Work?

The calculator uses the following formula:

\( \text{SR} = \frac{\text{RP}}{\sigma} \)

\( \text{RP} = \text{Ra} - \text{Rf} \)

Where:

\( \text{SR} \): Sharpe Ratio;
\( \text{RP} \): Risk Premium;
\( \text{Ra} \): Return of Asset (% as decimal);
\( \text{Rf} \): Risk-Free Return (% as decimal);
\( \sigma \): Standard Deviation (% as decimal).

Steps:

Enter the asset return as a percentage.
Enter the risk-free return as a percentage.
Enter the standard deviation of the asset's returns as a percentage.
Calculate the risk premium (Ra - Rf) and divide by the standard deviation to get the Sharpe Ratio.
Display the result, formatted in scientific notation if the absolute value is less than 0.001, otherwise with 4 decimal places.

3. Importance of Sharpe Ratio Calculation

Calculating the Sharpe Ratio is essential for:

Risk-Adjusted Performance: Measures return per unit of risk, enhancing investment analysis.
Portfolio Comparison: Allows comparison of investments with different risk levels.
Investment Strategy: Guides allocation to optimize risk-return trade-offs.

4. Using the Calculator

Example: Calculate the Sharpe Ratio for an asset with a return of 12%, a risk-free return of 3%, and a standard deviation of 15%:

\( \text{Ra} \): 12%;
\( \text{Rf} \): 3%;
\( \sigma \): 15%;
\( \text{RP} \): \( 0.12 - 0.03 = 0.09 \);
\( \text{SR} \): \( \frac{0.09}{0.15} = 0.6000 \).

5. Frequently Asked Questions (FAQ)

Q: What is a good Sharpe Ratio?
A: A Sharpe Ratio above 1 is generally considered good, indicating a favorable risk-adjusted return; above 2 is excellent.

Q: Can the Sharpe Ratio be negative?
A: Yes, if the asset return is less than the risk-free rate, the Sharpe Ratio will be negative.

Q: Why use standard deviation as risk?
A: Standard deviation measures the volatility of returns, providing a quantifiable risk metric for the Sharpe Ratio.