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FRM Part II · FRM Exam Part II · VaR and Risk Budgeting in Investment Management

A fund manager compares two portfolios using the Sharpe ratio. Portfolio A has an expected return of 9%, volatility of 12%, and the risk-free rate is 3%. Portfolio B has an expected return of 7% and volatility of 6%. Which statement is correct?

Portfolio B has the higher Sharpe ratio. Its excess return of 4% over 6% volatility gives 0.67, while Portfolio A's excess return of 6% over 12% volatility gives 0.50. B earns more excess return per unit of total risk.

  1. APortfolio A has the higher Sharpe ratio, 0.50 versus 0.67
  2. BPortfolio B has the higher Sharpe ratio, 0.67 versus 0.50Correct
  3. CBoth portfolios have the same Sharpe ratio of 0.50
  4. DPortfolio B has the higher Sharpe ratio, 1.17 versus 0.75

Explanation

Sharpe A = (9%-3%)/12% = 0.50. Sharpe B = (7%-3%)/6% = 0.667. B is higher. Option A reverses the values; option D forgets to subtract the risk-free rate (7/6=1.17, 9/12=0.75).

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