CA Final · Advanced Financial Management · Mutual Funds
An investor compares four equity schemes using the risk-free rate of 6%. Scheme A has a return of 15% and standard deviation of 10%. Scheme B has a return of 18% and standard deviation of 16%. Scheme C has a return of 12% and standard deviation of 5%. Scheme D has a return of 20% and standard deviation of 20%. Which scheme offers the best reward per unit of total risk?
Scheme C has the best reward per unit of total risk. Its Sharpe ratio is (12 − 6)/5 = 1.20, against 0.90 for A, 0.75 for B and 0.70 for D. Scheme D has the highest return but takes proportionally more risk.
- AScheme CCorrect
- BScheme A
- CScheme B
- DScheme D
Explanation
Sharpe ratio = (return − risk-free)/standard deviation. A = 9/10 = 0.90; B = 12/16 = 0.75; C = 6/5 = 1.20; D = 14/20 = 0.70. Scheme C is the highest. Scheme D has the highest raw return but the lowest Sharpe ratio.
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