Question 1

What is the Sharpe ratio?

Accepted Answer

The Sharpe ratio measures the return earned in excess of the risk-free rate per unit of volatility or total risk. It’s widely used to assess risk-adjusted performance.

Question 2

When is a Sharpe ratio considered good?

Accepted Answer

A Sharpe ratio above 1 is generally considered good, above 2 very good, and above 3 excellent—though this depends on the asset class and market conditions.

Question 3

Can I compare different portfolios using Sharpe ratios?

Accepted Answer

Yes, Sharpe ratios are useful for comparing the risk-adjusted performance of different portfolios, funds, or strategies using a consistent framework.

Question 4

What inputs are required to calculate the Sharpe ratio?

Accepted Answer

To calculate the Sharpe ratio, you need the average return of the portfolio, the risk-free rate, and the standard deviation of portfolio returns over the same period.

Question 5

Can the Sharpe ratio be negative?

Accepted Answer

Yes. A negative Sharpe ratio means the portfolio underperformed the risk-free rate, indicating poor risk-adjusted returns or consistent losses.

Question 6

Is the Sharpe ratio suitable for all investment types?

Accepted Answer

The Sharpe ratio works best for normally distributed returns and liquid investments. It may be less reliable for assets with asymmetric or non-linear risk profiles, such as options or illiquid holdings.