A measure of risk-adjusted performance that is often used is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviation and return of the funds over the past 10 years are listed below. Calculate the Sharpe ratio for each of these funds. Assume that the expected return and standard deviation of the company stock will be 15 percent and 65 percent, respectively. Calculate the Sharpe ratio for the company stock. How appropriate is the Sharpe ratio for these assets? When would you use the Sharpe ratio?

     

10-YEAR ANNUAL RETURN	STANDARD DEVIATION
Bledsoe S&P 500 Index Fund	10.15%	23.85%
Bledsoe Small Cap Fund	14.83	29.62
Bledsoe Large Company Stock Fund	11.08	26.13
Bledsoe Bond Fund	8.15	10.34

Step-by-step solution

Step 1 of 3

Sharpe Ratio measures the risk premium of the portfolio relative to the total amount of risk in the portfolio. The risk premium is the difference between the portfolio’s average return and the risk free rate of return. The standard deviation of the portfolio indicates the risk.

 

Sharpe Ratio=( Average return -Risk free rate of interest)/Standard deviation