What does the Sharpe Ratio measure?

The Sharpe Ratio is a financial metric that evaluates the performance of an investment or a portfolio by adjusting for its risk. More specifically, it measures the excess return per unit of risk taken, emphasizing the return generated beyond the risk-free rate compared to the level of risk, typically represented by standard deviation.

By dividing the difference between the portfolio return and the risk-free rate by the portfolio's standard deviation, the Sharpe Ratio enables investors to assess how well the return of an asset compensates for the risk taken. A higher Sharpe Ratio indicates a more favorable risk-adjusted return, making it a valuable tool for comparing different investment options or portfolios with varying levels of risk.

In this context, the other choices do not correctly describe the Sharpe Ratio. The total cost of an investment portfolio pertains to expenses associated with maintaining that portfolio, while the absolute return relates solely to the raw return without factoring in risk. Historic volatility focuses on past fluctuations in asset prices but does not directly measure returns relative to risk, which is the core function of the Sharpe Ratio.