WallStreetMojo

WallStreetMojo

WallStreetMojo

MENUMENU
  • Free Tutorials
  • Certification Courses
  • 250+ Courses All In One Bundle
  • Login
Home » Asset Management Tutorials » Portfolio Management in Finance » Sharpe Ratio Formula

Sharpe Ratio Formula

Formula to Calculate Sharpe Ratio

Sharpe ratio formula is used by the investors in order to calculate the excess return over the risk-free return, per unit of the volatility of the portfolio and according to the formula risk-free rate of the return is subtracted from the expected portfolio return and the resultant is divided by the standard deviation of the portfolio.

Sharpe Ratio = (Rp – Rf)/ σp

Sharpe Ratio Formula

Where,

  • Rp = Return of portfolio
  • Rf  = Risk-free rate
  • σp = Standard deviation of the portfolio’s excess return.

How to Calculate Sharpe Ratio?

  • The Sharpe ratio is calculated by dividing the difference of return of the portfolio and risk-free rate by the Standard deviation of the portfolio’s excess return. Through this, we can evaluate the investment performance based on the risk-free return.
  • A Higher Sharpe metric is always better than a lower one because a higher ratio indicates that the portfolio is making a better investment decision.
  • The Sharpe ratio also helps to explain whether portfolio excess returns are due to a good investment decision or a result of too much risk. As higher the risk higher return, lower the risk lowers the return.
  • If one of a portfolio has a higher return than that of its competitors, then it’s a good investment as the return is high and risk is the same. It’s about maximizing returns and reducing volatility. If any investment has a rate of return, 15% and volatility are zero. Then the Sharpe ratio will be infinite. As volatility increases, the risk significantly goes up as a result rate of return also increases.

Let us see the grading threshold of the Sharpe ratio.

  1. <1 – Not good
  2. 1-1.99 – Ok
  3. 2-2.99 – Really good
  4. >3 – Exceptional

Portfolio with zero risks like only the Treasury bill, as an investment is risk-free, there is no volatility and no earnings in excess of the risk-free rate. Thus, the Sharpe ratio has zero portfolios.

  • A metric 1, 2, 3 have a high rate of risk. If the metric is above or equal to 3, it is considered a great Sharpe measurement and a good investment.
  • Whereas it is a metric of between greater or equal to 1 and 2 less than 2, it is considered to just ok and if a metric is between greater than or equal to 2 and less than three, than it is considered that it is really good.
  • If a metric is less than one, then it is not considered as good.

Examples

You can download this Sharpe Ratio Formula Excel Template here – Sharpe Ratio Formula Excel Template

Example #1

Suppose there are two mutual funds to compare with different portfolios having different risk levels. Now let us see the Sharpe ratio to see which one is better performing.

Investment of Mid Cap stock Fund and details are as follows:-

  • Portfolio return = 35%
  • Risk free rate = 15%
  • Standard Deviation = 15

So the calculation of the Sharpe Ratio will be as follows-

Popular Course in this category
Sale
All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)
4.9 (1,067 ratings)
250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion
View Course
  • Sharpe Ratio Equation = (35-10) / 15
  • Sharpe Ratio = 1.33

Investment of Bluechip Fund and details are as follows:-

  • Portfolio return = 30%
  • Risk free rate = 10%
  • Standard Deviation = 5

So the calculation of the Sharpe Ratio will be as follows-

  • Sharpe Ratio = (30-10) / 5
  • Sharpe Ratio = 4

Therefore the Sharpe ratios of an above mutual fund are as below-

  • Bluechip Fund = 4
  • Mid Cap fund = 1.33

The blue-chip mutual fund outperformed Mid cap mutual fund, but it does not mean that Mid cap mutual fund performed well relative to its risk level. The Sharpe tell us below things:-

  • The blue-chip mutual fund performed better than Mid cap mutual fund relative to the risk involved in the investment.
  • If Mid cap mutual fund performed as well as the Blue-chip mutual fund relative to risk, it would earn a higher return.
  • The blue-chip mutual fund has earner higher return this year, but as risk is high. Hence, it will have high volatility in the future.

Example #2

Here, one investor is holding a $5,00,000 invested portfolio with an expected rate of return of 12% and a volatility of 10%. The efficient portfolio expects a return above 17% and a volatility of 12%. The risk-free interest is 4%. The calculation of the Sharpe ratio can be done as below:-

  • Sharpe ratio = (0.12 – 0.04) / 0.10
  • Sharpe ratio = 0.80

Sharpe Ratio Calculator

You can use the following Sharpe Ratio Calculator.

Return of Portfolio
Risk Free Rate
Standard Deviation of Portfolio's Excess Return
Sharp Ratio Formula =
 

Sharp Ratio Formula =
Return of Portfolio − Risk Free Rate
=
Standard Deviation of Portfolio's Excess Return
0-0
= 0
0

Advantages

Advantages of the Sharpe ratio are as follows:-

  • The ratio is the average return earned in excess of the risk-free rate per unit volatility or total risk
  • Sharpe ratio helps in comparisons of investment.
  • Sharpe ratio helps in risk-return comparisons.

There are some issues while using the Sharpe ratio that it is calculated in an assumption that investment returns are normally distributed, and that is resulting in relevant interpretations of Sharpe ratio to be misguiding.

Sharpe Ratio Calculation in Excel

In the below-given template is the data for the Mid Cap Mutual Funds and Bluechip Mutual Funds for the calculation of the Sharpe ratio.

Excel calculation example

In the below given excel template, we have used the calculation of the Sharpe ratio equation to find the Sharpe ratio.

Excel calculation example

So the calculation of the Sharpe Ratio will be-

Excel calculation example

Recommended Articles:

This has been a guide to Sharpe Ratio Formula. Here we discuss how the investors use this formula to understand the return on investment compared to risk on it along with practical examples and Calculator. You can learn more about Portfolio Management from the following articles –

  • Calculate Risk-Free Rate
  • Calculate Treynor Ratio
  • Stock vs Mutual Funds Differences
  • How to make a career in Portfolio Management?
5 Shares
Share
Tweet
Share
Primary Sidebar
Footer
COMPANY
About
Reviews
Contact
Privacy
Terms of Service
RESOURCES
Blog
Free Courses
Free Tutorials
Investment Banking Tutorials
Financial Modeling Tutorials
Excel Tutorials
Accounting Tutorials
Financial Statement Analysis
COURSES
All Courses
Financial Analyst All in One Course
Investment Banking Course
Financial Modeling Course
Private Equity Course
Venture Capital Course
Excel All in One Course

Copyright © 2021. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. CFA® And Chartered Financial Analyst® Are Registered Trademarks Owned By CFA Institute.
Return to top

WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Book Your One Instructor : One Learner Free Class
WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Let’s Get Started
Please select the batch
Saturday - Sunday 9 am IST to 5 pm IST
Saturday - Sunday 9 am IST to 5 pm IST

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Login

Forgot Password?

WallStreetMojo

Download Sharpe Ratio Formula Excel Template

New Year Offer - All in One Financial Analyst Bundle (250+ Courses, 40+ Projects) View More