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NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Performance Measurement and Evaluation of Portfolio Managers

Which statement about the Sharpe ratio, used to evaluate a portfolio manager, is correct?

The Sharpe ratio measures excess return over the risk-free rate per unit of standard deviation, which is total risk. It is distinct from the Treynor ratio, which uses beta, and from the information ratio, which uses tracking error.

  1. AIt measures excess return over the risk-free rate per unit of standard deviationCorrect
  2. BIt measures excess return over the risk-free rate per unit of beta
  3. CIt measures return above the benchmark per unit of tracking error
  4. DIt measures the portfolio's return as a percentage of the benchmark return

Explanation

Sharpe ratio = (Portfolio return - Risk-free return) / Standard deviation of portfolio returns, so it uses total risk. Dividing by beta gives the Treynor ratio, and dividing active return by tracking error gives the information ratio.

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