Understanding the Sharpe Ratio in Performance Evaluation

Easy Performance Evaluation Risk-adjusted Measures

John is a portfolio manager who is evaluating the performance of his fund over the last year. He has obtained the following metrics:

- Fund Return: 12%

- Benchmark Return: 8%

- Standard Deviation of the Fund’s Returns: 10%

- Standard Deviation of the Benchmark’s Returns: 5%

To assess the risk-adjusted performance of the fund relative to its benchmark, John decides to calculate the Sharpe Ratio. Which of the following statements best describes the correct interpretation of the Sharpe Ratio?

A higher Sharpe Ratio indicates that the fund has a better risk-adjusted return than the benchmark.

The Sharpe Ratio is useful only when comparing funds with similar returns.

A negative Sharpe Ratio means that the fund has underperformed the risk-free rate.

Hint

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