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Finance Dictionary and Glossary of Investment Terms
Sharpe Ratio
Definition 1.
A measure of how well a mutual fund rewards risk; the higher the Sharpe ratio, the better the fund''s historical risk-adjusted performance. The Sharpe ratio is a risk-adjusted measure developed by Nobel Laureate William Sharpe. It is calculated using standard deviation and excess return to determine reward per unit of risk. First, the average monthly return of the 90-day Treasury bill (over a 36-month period) is subtracted from the fund''s average monthly return. The difference in total return represents the fund''s excess return beyond that of a riskless investment (the 90-day T-bill). An arithmetic annualized excess return is then calculated by multiplying this monthly return by 12. To show a relationship between excess return and risk, this number is then divided by the standard deviation of the fund''s annualized excess returns.
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