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FRM Part II · FRM Exam Part II · The Investment Function in Financial Services Management

A bank's treasury manager reviews a securities portfolio that returned 6.0% over the year. The average one-year risk-free rate was 2.0%, and the portfolio's standard deviation of returns was 8.0%. What is the portfolio's Sharpe ratio?

The Sharpe ratio is 0.50. It equals the excess return over the risk-free rate, 6% minus 2% or 4%, divided by the portfolio's 8% standard deviation. Using the total return of 6% without deducting the risk-free rate would wrongly give 0.75.

  1. A0.25
  2. B0.50Correct
  3. C0.75
  4. D3.00

Explanation

Sharpe ratio = (portfolio return - risk-free rate) / standard deviation = (6.0% - 2.0%) / 8.0% = 0.50. Choosing 0.75 comes from dividing the raw return by the standard deviation without subtracting the risk-free rate (6/8). Choosing 0.25 divides the excess return by the total return incorrectly scaled, and 3.00 divides the return by the risk-free rate.

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