You are provided below with annual return, standard deviation of returns, and tracking error to the...

You are provided below with annual return, standard deviation of returns, and tracking error to the relevant benchmark for three portfolios. Please calculate the Sharpe Ratio for the three portfolios

Portfolio	Return	Standard Deviation	Tracking Error
1	15.50%	19.00%	1.50%
2	13.25%	24.00%	7.00%
3	18.00%	23.00%	8.00%
Index	14.00%	20.00%
Risk-Free	5.00%

Expert Solution

Sharpe Ratio :- It indicates the return ,over and above the risk free return of the portfolio adjusted with risk associated with the portfolio. It gives an idea to investor how much return is generated by the portfolio for the risk taken. Higher the Sharpe ratio better the portfolio Since higher Sharpe ratio shows higher return for the risk involved in the portfolio.

Formula:- (Expected return - Risk Free return) / Standard deviation

Portfolio 1. = (15.50% - 5% ) / 19% = 0.55

Portfolio 2 = ( 13.25% - 5% ) / 24% = 0.34

Portfolio 3. = ( 18% - 5% ) / 23% = 0.57

Tracking error shows the deviation from benchmark of the portfolio. Lower tracking error means portfolio return is stick near to the benchmark and higher tracking error means high volatility in return.

In the above given calculations as per Sharpe ratio portfolio 3 is better however its tracking error is highest. Hence As per the Sharpe ratio and tracking error portfolio 1 is better among all three. Since it has lower tracking error and relatively high Sharpe ratio.

jeff jeffy answered 1 year ago

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