Sharpe ratio

What it means

Excess return over the risk-free rate, per unit of total risk.

The exam angle

Uses total risk, so it judges a portfolio held on its own. It flatters strategies with negatively skewed returns, because standard deviation does not see the tail.

Where it appears in the syllabus

• Portfolio ConstructionCFA Level I · exam weight 8–12% · Risk and return, the CAPM, IPS construction, behavioural biases.
• Performance MeasurementCFA Level III · exam weight 5–10% · Attribution, appraisal, manager selection and the GIPS standards.
• Foundations of Risk ManagementFRM Part I · exam weight 20% · Risk taxonomy, governance, CAPM, multifactor models, financial disasters.

Related terms

• AlphaReturn in excess of what the asset’s risk exposures would predict.
• BetaThe sensitivity of an asset’s return to the market’s return — its share of systematic risk.
• Capital asset pricing modelA model stating that an asset’s expected return equals the risk-free rate plus beta times the equity risk premium.
• DiversificationCombining imperfectly correlated assets so that portfolio risk falls below the weighted average of the individual risks.
• Information ratioActive return divided by tracking error — value added per unit of benchmark-relative risk.
• Systematic riskRisk affecting the whole market, which cannot be diversified away.