Stocks A and B have the following historical returns: Year Stock A’s Returns Stock B’s Returns 2015 (24.25%) 5.50% 2016 18.50 26.73 2017 38.67 48.25 2018 14.33 (4.50) 2019 39.13 43.86 Assume the risk-free rate during this time was 3.5%. What are the Sharpe ratios for Stocks A and B and the portfolio over this time period using their average returns? Answers: a) Sharpe ratio for Stock A = b) Sharpe ratio for Stock B = c) Sharpe ratio for Portfolio AB =
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Stocks A and B have the following historical returns:
| Year | Stock A’s Returns | Stock B’s Returns |
| 2015 | (24.25%) | 5.50% |
| 2016 | 18.50 | 26.73 |
| 2017 | 38.67 | 48.25 |
| 2018 | 14.33 | (4.50) |
| 2019 | 39.13 | 43.86 |
Assume the risk-free rate during this time was 3.5%. What are the Sharpe ratios for Stocks A and B and the portfolio over this time period using their average returns?
Answers:
a) Sharpe ratio for Stock A =
b) Sharpe ratio for Stock B =
c) Sharpe ratio for Portfolio AB =
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