Nobel Laureate

William Sharpe developed the idea of
quantifying an

investment's return in excess of a
guaranteed investment (the 90-day U.S.

Treasury-bill), relative to the risk of the investment.

To calculate the Sharpe ratio, divide the
expected return of an investment that is in excess
of the guaranteed investment by the standard deviation
of those returns.

For example, if the guaranteed investment produced a return
of 5%, and the investment under consideration is known to
have a return of 10% with a standard deviation of 7.3, then
S = (10 - 5) / 7.3
For a Sharpe Ratio of `0.6849`--not a very good ratio. According to Sharpe, you would do better to invest in the 5% guaranteed investment.

As another example, if the guaranteed investment produced
a return of 5%, and the investment under consideration
is known to have a return of 27% with a standard deviation of 4.9, then
S = (27 - 5) / 4.9
For a Sharpe Ratio of `4.4897`--a fine investment
choice (according to the Sharpe Ratio).