1. What is the Sharpe Ratio?

The Sharpe Ratio measures the risk-adjusted return of an investment. It compares the excess return of an investment (above the risk-free rate) to its volatility, providing insight into how much additional return you receive for the extra volatility endured.

2. How Does the Calculator Work?

The calculator uses the Sharpe Ratio formula:

Where:

• \( Stock\ Return \) — The return of the stock or portfolio (in decimal form)
• \( Rf \) — The risk-free rate (in decimal form)
• \( Stock\ Volatility \) — The standard deviation of the stock's returns (in decimal form)

Explanation: The ratio shows how well the return of an asset compensates the investor for the risk taken. Higher ratios indicate better risk-adjusted returns.

3. Importance of Sharpe Ratio

Details: The Sharpe Ratio is widely used in finance to compare the risk-adjusted performance of different investments or portfolios. It helps investors understand whether higher returns are due to smart investment decisions or excessive risk.

4. Using the Calculator

Tips: Enter the stock return, risk-free rate, and stock volatility as decimals (e.g., 0.08 for 8%). Volatility must be greater than zero.

5. Frequently Asked Questions (FAQ)

Q1: What is a good Sharpe Ratio?
A: Generally, a Sharpe Ratio of 1.0 or higher is considered good, 2.0 or higher is very good, and 3.0 or higher is excellent.

Q2: What risk-free rate should I use?
A: Typically, the 3-month U.S. Treasury bill rate is used as the risk-free rate proxy.

Q3: Can the Sharpe Ratio be negative?
A: Yes, a negative Sharpe Ratio indicates that the risk-free rate exceeds the portfolio's return.

Q4: What are the limitations of the Sharpe Ratio?
A: It assumes returns are normally distributed and that volatility adequately captures risk. It may not fully account for tail risks.

Q5: How does this differ from the Sortino Ratio?
A: The Sortino Ratio only considers downside volatility, while Sharpe considers total volatility.