What does a higher Sharpe Ratio indicate about a portfolio?

What does a higher Sharpe Ratio indicate about a portfolio?

• A. Lower risk for the same return
• B. Higher returns with higher risk
• C. Higher risk for the same return
• D. Lower returns with lower risk

Answer: (A)

A higher Sharpe Ratio indicates that a portfolio is generating more return per unit of risk. This metric is calculated by taking the difference between the portfolio’s return and the risk-free rate, and then dividing it by the portfolio’s standard deviation (which serves as a measure of risk). Therefore, when the Sharpe Ratio is higher, it means that for a given level of risk, the portfolio is achieving a higher return compared to others with lower ratios. This relationship emphasizes the portfolio's efficiency in terms of risk-adjusted performance; investors prefer portfolios that offer greater returns without a corresponding increase in risk. In practical terms, this implies that if two portfolios provide the same return but one has a higher Sharpe Ratio, the one with the higher ratio is preferred because it entails less risk for the equivalent return. Thus, a higher Sharpe Ratio indeed signals lower risk for the same return, making the chosen answer accurate.

A higher Sharpe Ratio indicates that a portfolio is generating more return per unit of risk. This metric is calculated by taking the difference between the portfolio’s return and the risk-free rate, and then dividing it by the portfolio’s standard deviation (which serves as a measure of risk). Therefore, when the Sharpe Ratio is higher, it means that for a given level of risk, the portfolio is achieving a higher return compared to others with lower ratios.

This relationship emphasizes the portfolio's efficiency in terms of risk-adjusted performance; investors prefer portfolios that offer greater returns without a corresponding increase in risk. In practical terms, this implies that if two portfolios provide the same return but one has a higher Sharpe Ratio, the one with the higher ratio is preferred because it entails less risk for the equivalent return. Thus, a higher Sharpe Ratio indeed signals lower risk for the same return, making the chosen answer accurate.