Chartered Market Technician (CMT) Practice Exam 2025 – Your All-in-One Guide to Exam Success!

The Sharpe Ratio is a measure used to evaluate the risk-adjusted return of an investment or a portfolio. It is calculated by taking the mean excess return (the return of the investment minus the risk-free rate) and dividing it by the standard deviation of the excess return. This calculation provides insight into how much excess return is being received for the level of risk taken.

The mean excess return reflects the performance of the investment relative to a risk-free asset, allowing investors to assess the true benefit of accepting additional risk. The standard deviation of excess return serves as a measure of that risk, quantifying the volatility and uncertainty around the returns.

By using this ratio, investors can compare different investments or portfolios by understanding how well they compensate for the risk involved, offering a more complete picture than returns alone. This is particularly valuable in the context of portfolio management and optimization, where the objective is to maximize returns while managing risk effectively.