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NISM Certifications · NISM-Series-V-A: Mutual Fund Distributors · Risk, Return and Performance of Funds

Scheme A has an average annual return of 14%, and a standard deviation of 10%. The risk-free rate is 6%. Scheme B has a return of 12%, and a standard deviation of 5%. Based on the Sharpe ratio, which statement is correct?

Scheme B is better. Its Sharpe ratio is (12-6)/5 = 1.2, while Scheme A's is (14-6)/10 = 0.8. A higher Sharpe ratio means more excess return over the risk-free rate for each unit of risk taken.

  1. AScheme A is better, with a Sharpe ratio of 0.8 versus 1.2 for B
  2. BScheme B is better, with a Sharpe ratio of 1.2 versus 0.8 for ACorrect
  3. CScheme A is better, with a Sharpe ratio of 1.4 versus 2.4 for B
  4. DBoth have the same Sharpe ratio

Explanation

Sharpe for A = (14 - 6)/10 = 0.8. Sharpe for B = (12 - 6)/5 = 1.2. B delivers more excess return per unit of risk. Option 3 forgets to subtract the risk-free rate and also contradicts itself by calling A better.

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