Sharpe Ratio vs M2
გვერდები: 939
გაწევრიანდა: 21/04/2011
I heard that both ratio represent risk adjusted return. Can any one here explain these ratios? How it will help novice traders like me?
Stick to your rules
გვერდები: 29
გაწევრიანდა: 09/05/2011
M2 (Modigliani-Modigliani measure) is derived from Sharpe ratio. Sharpe ratio is widely used among investors. But normally people do not understand the sharpe ratio results easily.
Sharpe Ratio Sharpe ratio is a unique one in its class. It is dimensionless but once you understand the meaning of its results, you will never use any other return-risk ratios. Formula to calculate Sharpe ratio is S(X) = (R(x) - R(f)) / S.D(X) where X = investment R(x) = rate of return for your investment R(f) = Risk free return (An investment where there is almost no chance of loosing e.g T.Bills etc) S.D(X) = Standard Deviation of R(x)
M2 To understand the Risk Adjusted return M2 was derived from Sharpe ratio. It is in a form of percentage and you can easily interpret its results. Formula to calculate it is : M2 = S(x) * S.D(y) + R(f) Where S.D(y) = Standard deviation of returns of another investment of the same level.
Result will be in the form of percentage. So you can easily compare investments by using M2. Whereas Sharpe ratio results are very difficult to compare.
I hope it helps you.
Bee There is no term like "sufficient money". So aim for a satisfied life.
გვერდები: 734
გაწევრიანდა: 22/04/2011
That was a nice explanation. Can you plz give an example of it?
The good or ill of a man lies within his own will. – Epictetus
გვერდები: 29
გაწევრიანდა: 09/05/2011
Example If your investment of$100 gave returns of $15,$(8),$7,$(5),$11,$2,$6,$6,$(10),0,14,10 each month Calculate the risk free return in your country. Say 12% per Annum.
Now average monthly return on your investment will be = (15 - 8 + 7 - 5 + 11 + 2 + 6 + 6 -10 + 0 + 14 + 10) / 12 = $ 4 / month Risk free return on $ 100 investment = $1 / month Standard deviation = 8.33 (you can easily caluclate it using "STDEV" function in excel
Put Values in Sharpe formula. It will look like (4-1)/8.33 = 0.36 .
Similarly you can calculate for M2 just by taking another investment of the same level and calculating its return then putting in formula. The results will be in percentage.
Regards
Bee There is no term like "sufficient money". So aim for a satisfied life.
გვერდები: 734
გაწევრიანდა: 22/04/2011
Thankyou Bee.
The good or ill of a man lies within his own will. – Epictetus