What is the primary purpose of the Sharpe Ratio?

The primary purpose of the Sharpe Ratio is to assess the risk-adjusted return relative to volatility, making the second choice the correct one. This financial metric is designed to help investors understand how much return they are receiving for the additional risk they are taking on compared to a risk-free asset. By calculating the excess return (the return of the investment above the risk-free rate) and dividing it by the investment's standard deviation (a measure of volatility), the Sharpe Ratio gives a clear picture of risk-adjusted performance.

A higher Sharpe Ratio indicates that the investment offers a better return for the level of risk, while a lower ratio suggests that the returns are not sufficient to justify the risks being taken. This is particularly important in the realm of asset management and portfolio optimization, where balancing return with risk is crucial for achieving investment goals.

Other options do not accurately capture the intent of the Sharpe Ratio. The first option, concerning market share, does not relate to investment performance in terms of risk and returns. The third option, about evaluating liquidity, refers to how easily an asset can be bought or sold without affecting its price, which is different from measuring investment returns and risks. Lastly, the fourth choice regarding the cost of capital deals with funding and