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.

That was a nice explanation. Can you plz give an example of it?

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

Thankyou Bee.