A statistical measure often used in modern portfolio theory to express risk-adjusted return, or return while incorporating volatility. Calculated as follows:
Sharpe Ratio = (Expected Return – Risk Free Rate of Return) / Standard Deviation
Prevailing rate of return for treasury notes (or T-note) often stands in for risk-free rate of return. This formula is often employed at the portfolio level to determine whether changes in allocation will have a positive or negative impact on the expected (ex ante) risk-adjusted return of a portfolio.
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