An equity mutual fund scheme delivers an annualized return of 16.0% with a Standard Deviation of 12.5%. If the risk-free rate of return is 6.0%, what is the Sharpe Ratio of the scheme?

[ A ]1.28 (Gross return divided by Standard Deviation without deducting risk-free rate)

[ B ]0.80 (Excess return per unit of Total Risk: (16.0% - 6.0%) / 12.5%)[ CORRECT ]

[ C ]10.00% (Excess return alone)

[ D ]1.25

Takeaway

Option B is correct: 0.80 (Excess return per unit of Total Risk: (16.0% - 6.0%) / 12.5%)

Derivation

Excess return above the risk-free asset is R_p − R_f = 16.0% − 6.0% = 10.0%. Total risk here is the fund's own Standard Deviation, 12.5%, which captures both systematic and unsystematic volatility. Sharpe Ratio = 10.0 / 12.5 = 0.80, meaning the scheme generates 0.80 units of excess return for every 1 unit of total volatility carried. Sharpe is the right lens for a standalone fund evaluated on its own risk-return trade-off, as opposed to Treynor, which divides by Beta and is only meaningful for a well-diversified holding inside a larger portfolio. Candidates commonly skip subtracting the risk-free rate, or divide by the wrong risk measure entirely.

Why the others fail

A — 1.28 (Gross return divided by Standard Deviation without deducting risk-free rate)

Skips subtracting the 6.0% risk-free rate before dividing by Standard Deviation, so it overstates the fund's true risk-adjusted excess return.

C — 10.00% (Excess return alone)

States the excess return of 10.0% on its own without dividing by Standard Deviation, so it is not actually a ratio at all.

D — 1.25

Inverts the calculation, dividing Standard Deviation by excess return (12.5 / 10.0) instead of excess return by Standard Deviation.