Sharpe Ratio: Understanding Risk-Adjusted Return in Investments
What is the most likely reason why Joaquim was not pleased with the high return he received?
A. He learned that the portfolio's volatility was 50%, so he could have made or lost $50,000.
B. Taking on this level of risk may not justify the return.
C. He learned that the portfolio's volatility was 50%, so he could have lost $100,000.
D. Taking on this level of risk may not justify the return.
E. He learned that the portfolio's volatility was 5%, so he could have made $100,000.
Answer:
Joaquim was not pleased with the high return once he learned about the Sharpe Ratio, most likely because of option C: He learned that the portfolio's volatility was 50%, so he could have made or lost $50,000.
The Sharpe Ratio is a measure of risk-adjusted return, which helps investors understand the relationship between the risk taken and the return earned on an investment. In Joaquim's case, the fund boasted a 25% return, which seemed attractive at first.
However, after learning about the Sharpe Ratio and the portfolio's high volatility of 50%, he realized that the level of risk associated with this investment was significant.
The fact that the portfolio's volatility was 50% means that the investment could have generated a return of $50,000, but it also could have resulted in a loss of the same amount. This level of risk may not justify the return for Joaquim, as he was expecting a more stable and secure investment.
By considering the Sharpe Ratio and the portfolio's volatility, Joaquim gained a better understanding of the relationship between risk and return, which is crucial for making informed investment decisions.