What does a higher Sharpe ratio indicate about an investment?

A higher Sharpe ratio indicates that an investment provides a higher return relative to its risk, effectively demonstrating a lower risk per unit of return. The Sharpe ratio is calculated by subtracting the risk-free rate from the investment's return and then dividing that by the investment's standard deviation (a measure of risk).

When the ratio increases, it implies that the investment is yielding a better return for every unit of risk taken compared to other investments or a benchmark. This is favorable for investors, as they prefer investments that maximize returns while minimizing risk.

Options related to lower risk per unit of return can be misleading; the key aspect of the Sharpe ratio is the marriage of return relative to its volatility. Consequently, while it does indicate lower risk in this context, its primary focus is enhancing returns for a given level of risk, not purely focusing on risk alone. Other options address different aspects not directly highlighted by the Sharpe ratio.