What does the Sharpe Ratio measure?

The Sharpe Ratio is a key financial metric used to assess the risk-adjusted performance of an investment or a portfolio. Specifically, it quantifies the return generated per unit of risk taken by comparing the excess return of the investment, which is its return minus the risk-free rate, to the standard deviation of those returns, representing the risk.

This ratio provides insight into how well the investment compensates an investor for the risk taken. A higher Sharpe Ratio indicates a more favorable risk-return tradeoff, demonstrating that an investor is receiving more return for each unit of risk associated with an investment.

While the other choices touch on concepts related to investments, they do not capture the essence of the Sharpe Ratio. The efficiency of a stock's return generally refers to how well a stock performs, but not necessarily in relation to the risks involved. Measuring total portfolio return against market indices focuses on comparison to benchmarks rather than the risk-adjusted measure provided by the Sharpe Ratio. Lastly, tracking the variance of a portfolio does indicate the degree of risk, but it does not make the connection to returns, which is central to the definition of the Sharpe Ratio.