The Sharpe ratio measures how much excess return you earn per unit of risk taken. A ratio above 1 is good. Comparing Sharpe ratios lets you evaluate whether higher returns are worth the extra risk taken.
Answer: Standard deviation of returns (volatility). Sharpe = (Return − Risk-free rate) ÷ Standard deviation. Higher Sharpe = better risk-adjusted return.
Answer: Fund A — better return per unit of risk. Fund A delivers the same return with less volatility — far superior on a risk-adjusted basis.
Answer: Sensitivity to market movements. Beta = 1 means moves with the market. Beta > 1 is more volatile; beta < 1 is less volatile than the market.
Answer: Return above what was expected given the market return and beta. Alpha is excess return over the benchmark after adjusting for market risk — the manager's (or strategy's) true added value.
Practice this with $10,000 in virtual cash in Tradecraft, free paper trading with real market data.
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