NISM Certifications · NISM-Series-V-A: Mutual Fund Distributors · Risk, Return and Performance of Funds
A fund earned an average annual return of 14% with a standard deviation of 10% and a beta of 1.25. The risk-free rate is 6%. What is its Sharpe ratio, and what does it use as the risk measure?
The Sharpe ratio is 0.80, calculated as excess return of 8 percentage points over the risk-free rate divided by the standard deviation of 10%. Sharpe uses total risk, whereas the Treynor ratio divides by beta and would give 6.40.
- A0.80, using standard deviationCorrect
- B1.40, using standard deviation
- C6.40, using beta
- D0.80, using beta
Explanation
Sharpe = (14 - 6) / 10 = 0.80, with standard deviation as the denominator. Dividing the excess return by beta (8/1.25 = 6.40) gives the Treynor ratio, in percentage terms. 1.40 wrongly divides the return without deducting the risk-free rate (14/10).
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