Financial Risk Manager Part 1

The Sharpe ratio is a measure of risk-adjusted return, which is calculated as the average return of a portfolio in excess of the risk-free rate, divided by the total risk of the portfolio. The total risk is measured by the standard deviation of the portfolio's returns, not its beta. In this scenario, both portfolios X and Y have the same average return and the same standard deviation of returns, which means they have the same total risk. Therefore, according to the Sharpe ratio, portfolios X and Y perform equally. The lower beta of portfolio Y does not affect the Sharpe ratio because the Sharpe ratio does not consider systematic risk, which is what beta measures. Instead, the Sharpe ratio considers total risk, which includes both systematic and unsystematic risk. Therefore, even though portfolio Y has a lower beta, it does not outperform portfolio X according to the Sharpe ratio.

Choice A is incorrect. The Sharpe ratio measures the excess return per unit of risk, which in this case is represented by standard deviation. Since both portfolios have the same average return and the same standard deviation, their Sharpe ratios are equal, meaning neither outperforms the other.