Once we start to learn about financial market and the portfolio investment or start to follow some financial guru to understand their investment approach towards financial market, it become clearer that we need to have some basic metric against which we can keep a track. Too much information sources and lot of buzz words can easily steer us off the track and we might lose the basic objective of why we enter the financial market at first place and that is to earn profit.

There exist a lot of different theories and different matrices that are helpful for us to keep track on what is happening because following theories only might not be the right approach. Here we will add information about two of such matrices.

First is Sharpe Ratio. It is the most widely used matric that is used to measure the effectiveness of any portfolio by comparing the returns of portfolio with its risk. To quantify the return-risk ratio, portfolio return is adjusted with risk free rate of return and thus only that part of return is used for which investor is bearing the risk.

Formulae for sharpe ratio,

                SR = (Rportfolio – Rrisk_free )/ σportfolio

Here, Rportfolio is the return on the portfolio

                R risk_free is the return on risk free asset such as treasury bill

                And σportfolio is the standard deviation of the portfolio returns.

Second comparable measure is the information ratio. Fund manager selects a benchmark for their portfolio. Benchmark helps to identify their investment strategy and is used to measure the success of fund manager investment strategy.

In information ratio risk and return is compared but both factors are adjusted for the benchmark

Formulae for Information ratio,

                IR= (Rportfolio– Rbenchmark)/ Tracking Error,

                Here, Rportfolio is the return on the portfolio

                Rbenchmark is the return on the benchmark

                Tracking error is the standard deviation of (Rportfolio – Rbenchmark)