Sharpe Ratio
The Sharpe ratio is one of the most well-known measures of risk-adjusted return. The Sharpe ratio rewards investments that show superior returns without taking excessive risk. Thus, high Sharpe ratios suggest high performance investments with low risk, while low Sharpe ratios suggest that performance may have been due to higher risk.
In the numerator of the formula above, the riskless rate of return is subtracted from the investment’s actual return. The riskless rate of return is the return on a kind of investment with, essentially, no risk. This is usually the rate of three-month