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NISM Certifications · NISM-Series-V-A: Mutual Fund Distributors · Mutual Fund Scheme Selection

An investor in the 3-year-old portfolio compares two funds with these 3-year data: Fund P average annual return 15%, standard deviation 10%; Fund Q average annual return 14%, standard deviation 7%. The risk-free rate is 6%. Based on the Sharpe ratio, which fund has better risk-adjusted performance?

Fund Q has the better risk-adjusted performance. Sharpe ratio is excess return over the risk-free rate divided by standard deviation: Fund P gives 9/10 = 0.90 while Fund Q gives 8/7 = 1.14, so Q earns more per unit of risk.

  1. AFund P, with Sharpe ratio 0.90, versus Fund Q with 1.14
  2. BFund Q, with Sharpe ratio 1.14, versus Fund P with 0.90Correct
  3. CFund P, with Sharpe ratio 1.50, versus Fund Q with 2.00
  4. DFund Q, with Sharpe ratio 2.00, versus Fund P with 1.50

Explanation

Sharpe = (return - risk-free)/standard deviation. Fund P: (15-6)/10 = 0.90. Fund Q: (14-6)/7 = 8/7 = 1.14. Fund Q is higher, so it has better risk-adjusted performance. The first option reverses the conclusion; the others forget to subtract the risk-free rate.

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