Sharpe Ratio

While deciding about what investments to make, one should weigh the rewards versus the risks of the investment opportunity. The Sharpe ratio is one popular measure of return on risk. It is named after Nobel Laureate professor William F. Sharpe.

The Sharpe ratio measures the reward (or excess return) of an asset per unit of risk.

The Sharpe ratio is also commonly expressed as:

sr1
sr1

Both the return and the standard deviation are annualized. To annualize returns, you multiply linearly by time. For example, a monthly return of 1% converts to an annualized return of 12%. Standard deviation of return is a measure of risk, or uncertainty, of returns. To annualize standard deviation, multiply by the square root of time.

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