Sharpe Ratio
Private Credit glossary · Underwriting & Credit Analysis
Definition
(Return - Risk-free rate) / Standard deviation; risk-adjusted return per unit of volatility.
Sharpe Ratio in plain English
The Sharpe ratio answers a simple question: how much extra reward did an investment give you for each unit of stomach-churning ups and downs it put you through? You start with the return, subtract the "risk-free rate" (what you'd earn parking money somewhere ultra-safe like government bonds, since that part took no real risk), then divide by the standard deviation, a measure of how wildly the returns bounced around. A higher Sharpe ratio means you got more reward per unit of nerve-wracking volatility — it's like comparing two roller coasters not just by how far they climb, but by how smooth the ride was for that same thrill. It lets you fairly compare a calm investment against a wild one instead of being fooled by big returns that came with huge risk.
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